Markets were thrown into chaos yesterday when the Federal Reserve announced it would not be reducing its controversial quantitative easing program in the immediate future. After trading flat ahead of the Fed's statement the Dow Jones Industrial Average (^DJI) closed up 147 points at a record 15,677. The S&P500 (^GSPC) also closed at a record high at 1,725.5.
The S&P 500 is now up 18% in 2013 after rallying more over 4% in less than two weeks.
The prospect of more money printing triggered a flight to safety as yields on 10-year Treasury (^TXN) notes dropped to 2.7% and gold rallied a stunning 4.5% to $1,366.50.
With markets around the world rallying this morning traders are left wondering exactly what on earth happened and how they could have been so poorly positioned going into the news.
The Decision Not to Begin Tapering QE Shouldn't Have Come as a Huge Surprise
The January FOMC statement stated very specifically that the Fed was targeting an unemployment rate below 6.5% and would do whatever it deemed necessary to achieve that goal provided “inflation between one and two years ahead is projected to be no more than a half a percentage point above the Committee’s 2% longer-run goal.”
Unemployment remains well over 7%, a figure Bernanke himself beliefs understates the real rate. The Fed's official Economic Projections regarding inflation have a "Central Tendency" range of 1.7 - 2% for 2016. The most hawkish of the the Federal Reserve Bank Presidents are now looking for inflation of 2.3% in 2016.
Core PCE Inflation is what the Fed uses as a benchmark. It currently stands at 1.2%. The only thing the Fed fears more than inflation is deflation. A 1.2% reading for core PCE is dangerously low.
What got the bond market all worked up in June was Bernanke's statement that if inflation continued to rise towards 2%, the jobs market improved, and fiscal headwinds subsided, they said "it would be appropriate to moderate the monthly pace of purchases later this year."
"I would like to emphasize once more the point that our policy is in no way predetermined," Bernanke added. "(It) will depend on the incoming data and the evolution of the outlook as well as on the cumulative progress toward our objective."
Since Bernanke made that statement on June 19th the job market is slightly improved, core PCE has fallen and fiscal policy remains a hellish quagmire. Further, the bond market has raised rates substantially, creating another economic challenge. The best case to be made for ending QE was Bernanke's pending retirement.
Bernanke made his decision not to taper based on the data; just as he said he would.
Quantitative easing may end in spiraling inflation and a hellish economic dystopia but that's no more likely today than it was yesterday. Whatever you think of Bernanke's policies, the man has unfailingly done exactly what he said he was going to do.
Individual Investors Chasing Momentum, Professionals Playing Catch-Up
For all the whining among the "smart money" most money managers have a big problem with less than two full weeks left in the third quarter. The S&P is now up 18%, hugely outperforming the average hedge fund. The pros may sneer at the rally but that won't cut it with their outside investors.
The choice for fund managers is clear: either double down on shorts or start chasing momentum and try to catch up. The Fed is driving growth at all costs. Like it or not that's bullish for stocks. In the long-haul the jury is out as to the impact of Bernanke's unprecedented experiment in stimulus. In the here and now fighting the Fed is a losing game.
One of the first rules of survival in the financial jungle is to trade the market you have rather than the one you want. Love it or hate it Bernanke's policy is clear and undeniable. History suggests accepting reality is more lucrative than moral outrage.
- Budget, Tax & Economy
- Federal Reserve