According to Sumner, among others, what matters in a Fed action is the gap between what was expected and what was done:
"recall that markets respond to new information. The market response won’t show the effect of the policy. It will show the effect of the difference between the expected policy and the actual policy. If the announcement doesn’t significantly affect the market it probably means that the announcement was roughly what the market expected."
http://www.themoneyillusion.com/?p=15613&cpage=1#comment-173940
It seems that the market got basically what it expected today. It wasn't particularly happy with Bernanke who just said if needed he'll do something-the refrain for the last 3 months. So what had been a mild rally coming in to Bernanke's words initially sold off. However, the losses than mitigated to almost entirely flat.
This CNBC piece this morning seemed to nail exactly what the Fed did:
"Fed Chairman Ben Bernanke is likely to do little more than keep the door open to more easing when the Fed winds up its meeting Wednesday afternoon."
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http://www.cnbc.com/id/48424415
This more or less nailed it. The market is expecting some more bond buying out of both the Fed and the ECB but didn't really expect much today:
"The CNBC Fed survey, released Tuesday showed that 89 percent of the market participants surveyed expect the ECB to purchase sovereign debt, and 78 percent expect more QE from the Fed. But just 26 percent expect the Fed to announce new easing Wednesday, and half the respondents expect it in September. They also expect a Fed asset purchase program to total more than $500 billion."
It seems to me that while the market wants Fed action, the Fed is basically trying to see if it really needs it's intervention. To the extent that today doesn't see a drastic sell off and also there was some data that seemed to show that while the recovery somewhat slowed it hasn't stopped based on some better than expected ADP numbers, maybe the Fed thinks it may have room not to act.
I would guess, though, that the ECB must act. Draghii set the table with his big talk about 'doing whatever's necessary, and believe me, it will be enough" but he must be seen to follow through. He certainly doesn't have the credibility to leave it there.
As you correctly point out, Sumner and the monetarists often say that the response of the stock market is a reasonable judge of Fed policy. If they equally believe success is based on nominal GDP growth then it only makes sense that both indicators are highly correlated. That, however, is not the case. NGDP growth this year is only about 3% yet stock markets are up nearly 10% (better than the historical average). Clearly both factors cannot show the success/failure of monetary policy unless we're considering a Schroedinger cat example.
ReplyDeleteJoshua that's a very interesting point. I pointed out in that other post you commented on that while he tries to claim that what led to the recession was the collapse of NGDP in the 4th quarter of 2008, the markets had clearly already been predicting a recession ever since Angelo Mozillo's July, 200. conference call
ReplyDeleteThe very next day we saw a 400 point drop in equities and this begun a year and a half bear market in stocks, that ended March 10, 2009.
It's interesting that you can trace the beginning and end of the bear market to the exact day.
Ok, you're Woj! I didn't realize at first.
ReplyDeleteGlad you picked on that. Back in 07-08 I was an options trader and recall huge upwards spikes following the Fed's surprise and large rate cuts. With oil prices surging higher, most traders I worked with thought the Fed was overreacting to economic weakness. Looking back now it's clear that the Fed was behind the curve, but ex post mistakes are almost always clear. Stock markets may hint at how policy matches expectations at that moment but they offer little guidance for the success of policy over most time periods.
ReplyDeleteSo you were an options trader-very interesting. I played options as an amateur back in 2008.
ReplyDeleteMy theory was simple-short the banks. For me "shorting" was simply stocking up low priced puts in BAC, C, and MS.
I made thousands in September and November of 2008.
The market itself-as opposed to market participatns like your fellow traders-clearly was signaling a bad recession right from July,, 2007.
The run up in commodities was a false dawn that also tricked the Fed.
Recall that in 2008 they were still worrying about inflation because of oil. In September-for God's sake-they were saying both inflation and recession worried them equally.
There have recently been a lot of stories about how over the last 11 years something like 55% of the markets rise has been on Fed days. The S&P accroding to some study would only be abuot 600 rather than 1300 if not for the huge immediate moves on Fed days.
So something like 1.2% in the trading year is responsible for 55% of the moves.
Those were good calls by you. The market may have topped out in the second half of '07, but following the Bear Stearns bailout the market rallied from ~1280 to ~1440. At the same time, the VIX dropped from over 30 to ~16. Sound familiar?
ReplyDeleteIn mid-'08, there was still no consensus on a recession (that had already begun) and most analysts were expecting a rally to new highs. I don't think we're in a recession yet, but profit growth in the US is already turning negative and will not come close to expectations for ~14% growth in Q4. Profits may not matter for the time being, but ultimately I believe they will come back into focus.