The Federal Reserve didn’t mean for its recent QEII announcement — that it would be reinvesting proceeds from its maturing securities portfolio — to so greatly affect investors.
So said Minnaepolis Fed president Narayana Kocherlakota in a (telling) Tuesday speech:
The FOMC’s decision has had a larger impact on financial markets than I would have anticipated. My own interpretation is that the FOMC action led investors to believe that the economic situation in the United States was worse than they, the investors, had imagined. In my view, this reaction is unwarranted. The FOMC’s decisions were largely predicated on publicly available data about real GDP, its various components, unemployment, and inflation. I would say that there is no new information about the current state of the economy to be learned from the FOMC’s actions or its statement.
“No new information” — but of course, the market didn’t interpret it that way.
In the three trading days following the Fed’s August 10 announcement the market did this:
The fall in nominal yields was expected given the Fed would be purchasing more US Treasuries. What was missing, however, was any corresponding rally in riskier assets. The (safe haven) dollar gained, crude oil fell and so did the S&P 500. In fact, almost the exact opposite occured compared to what happened the last time the Fed announced it would be pursuing quantitative easing.
Back then, following the March 18, 2009 announcement, the next three trading days looked like this:
Yields fell, but so did the dollar. Meanwhile, crude oil rose along with the S&P.
There are two things to note when comparing the two sets of market movements. Firstly, it’s August — trading is thin and position unwinds could well be a factor in the most recent movements. Secondly, the Fed’s most recent announcement is nothing — in terms of size — compared to its March 2009 decision.
A cynic, however, might look at the lacklustre reaction and think that the US central bank is losing some of its market-firepower in terms of unconventional monetary policy. And an even bigger cynic might think that the market is simply holding out — or pushing — for a bigger bout of unconventional policy.
Either way though, something’s out of sync here — the market or the Fed.