It’s not often I find myself bothered by the stock market’s reaction to the news, but the large move higher Friday didn’t make much sense to me. I understand in Bear markets, which we are in the initial stages of, that equity prices can move violently up and down. What struck me was a conversation on FinTwit, the financial subculture of Twitter, where traders and investors were discussing how Fed Chair Powell caved to the recent stock market decline and how soon he would implement Quantitative Easing 4.
The catalyst for this discussion stemmed from the panel talk at the American Economic Association’s annual meeting in Atlanta on Friday, where current Fed Chair Powell and former Fed Chair’s Yellen and Bernanke were asked topical questions about the economy and monetary policy.
Powell was questioned about the balance sheet unwinding program or Quantitative Tightening. When asked, Powell said if the circumstances warranted it, where the balance sheet unwinding program was interfering with the Fed’s primary objectives, they “wouldn’t hesitate to change it.”
Powell further clarified that the Fed’s primary policy tool is the Federal Funds rate, which the Federal Open Market Committee wishes to use to adjust monetary policy on a long-term basis.
Chair Powell went on to say that when the Fed unwinds its balance sheet, it lets its bonds mature, which forces the U.S. Treasury to borrow money from the public to pay the Fed for their maturing bond. Given the size of the U.S. Treasury’s borrowings and the small amount the Fed is unwinding, Powell doesn’t believe their “issuance is an important part of the story of the market turbulence.”
These brief comments were interpreted by the financial community to mean the Fed will not hesitate to ease monetary policy should the stock market continue falling. Even though Powell doesn’t believe the actions of the Fed caused the stock market to fall starting in October, the balance sheet normalization does affect the monetary base, which affects asset prices.
Investors responded by buying stocks under the belief the Fed has their back. It just goes to show how little investors understand monetary policy and the lags associated with it. The reason stock prices, Treasury yields, and real estate prices are falling, is due to the actions of the Fed.
For those who think Quantitative Easing is around the corner, it isn’t. Powell didn’t give any indication that he or any others on the FOMC board are ready to make a major policy change unless conditions warranted, such as a financial crisis. For now, investors can continue buying stocks on hope the Fed will protect them, but at the end of the month at the next FOMC meeting, we will find out that there is no change in the current monetary path.
Even if there was, due to the monetary lags, it would take between fourteen-to-eighteen months before any monetary easing affected the economy. In the meantime, the Fed will continue destroying $50 billion per month, which is the near-equivalent of a 0.25% rate hike each month. Continued monetary tightening will slow the global economy and cause stock prices to continue falling, much to the surprise of the Bulls.