'Anti-Goldilocks' And The Fed-Equities Nexus

Tyler Durden's picture

Some in the markets think that the Fed effectively targets equity prices, meaning that to predict Fed policy, one merely needs to track the US stock market. There is a curious circularity to this view, however: the Fed will not launch QE3 so long as stock prices are high, yet the stock market is high because it anticipates QE3. BofAML's chart-of-the-day is intrguingly similar to our 'QE Hopeyness' chart as it shows that stock and bond prices have decoupled since the summer, as QE3 expectations overwhelmed the weaker macroeconomic data to buoy equities. Now that recent data have improved, yields have risen - but so too have stocks. This "heads I win, tails you lose" aspect of stock prices rising regardless of the macro backdrop, BofAML believes, makes them a far less useful signal for Fed officials. Moreover, it creates the risk that the equity market could sell off after the 12-13 September FOMC meeting if the Fed disappoints.

BofAML: The Fed-Equities Nexus

Stocks as a signal for policy makers...

The stock market is just one component of financial conditions, and financial conditions are just one driver of the outlook for growth and inflation. The Fed wants to be forward-looking in light of the transmission lags of monetary policy. In the words of Dallas Fed President Richard Fisher, quoting hockey legend Wayne Gretzky, the Fed must “skate to where the puck [ie, the outlook] is going to be, not where it has been.” Financial conditions can signal where the outlook is going to be, but that role breaks down when financial markets are largely driven by policy expectations. No central banker wants to tie policy to a financial variable that itself is driven by policy expectations.


As Chart 1 above shows, financial conditions more broadly are not very far from where they were ahead of QE2. Chart 1 plots three measures produced by Fed researchers: a National Financial Conditions Index from the Chicago Fed and two Financial Stress Indexes, one each from the St. Louis and Cleveland Feds. All three are normalized measures in which higher values indicate more stress. The Chicago and St. Louis indexes co-move quite closely (95% correlation coefficient) despite their different construction and units; the correlation of the Cleveland measure with the other two exceeds 70%. Even though rising stock prices are indicative of better financial conditions, in some sense the equity market appears to have it right: broader financial conditions are not so strong to price out QE3.

...but not as a policy goal

On the other hand, the Fed is not targeting the stock market. True, the Fed wants to see financial conditions improve because this is a channel through which monetary policy has a positive impact upon the economy, including wealth effects and confidence. But Fed officials do not see targeting equity prices as even an intermediate goal of policy, let alone an end in itself. Despite market speculation about the strike price of the so-called “Bernanke put,” one never finds Fed officials themselves talking up stock prices or mentioning a specific target value. Rather, Fed officials are focused on their dual mandate — price stability and maximum sustainable employment — to the point that they augmented their statement in June with “sustained improvement in labor market conditions” as well as “a stronger economy recovery” as policy objectives that would potentially warrant additional accommodation.


On the inflation front, the data for the headline personal consumption expenditure (PCE) deflator — the Fed’s preferred measure — have softened to just a 1.5% annual inflation rate after running at 2-3% for a year (from March 2011 to 2012). This measure bottomed out at 1.4% ahead of QE2 in 2010. That said, core PCE inflation is running higher now (1.8%) than prior to QE2 (1.2%). But both headline and core inflation are not only below the Fed’s 2% long-run inflation target, but Fed officials expect them to remain there for some time. And although the Fed’s preferred computation of 5-year, 5-year forward breakeven inflation (Chart 2 above; FED5YEAR in Bloomberg) had not reached its 2010 low, it has remained in the range that preceded QE2. A little more weakness in the inflation data is probably necessary to make a compelling case for QE3 in September.

Conversely, many Fed officials have acknowledged that they are significantly underperforming the other part of their dual mandate: the unemployment rate has crept back up to 8.3% in July, where it stood in January, while the employment-topopulation ratio has shown no net improvement for the past several years (Chart 3 below). Even a positive surprise of 163,000 on July payrolls is unlikely to impress most Fed officials: in a normal recovery, in which job growth exceeds 200,000 for a while, 163,000 would be considered a modest disappointment.


What if the Fed disappoints?

This mixed data outlook makes the Fed call for the September meeting especially close. There is little doubt for us that if the data resume sliding to the downside, the Fed will step in and ease further this year. Right now, however, we are in an anti-Goldilocks period in which the data are too hot for clear-cut Fed easing, but too cold to support a sustained rebound — anything but “just right”.

Meanwhile, discussions with investors suggest that the equity markets have not yet priced in the fiscal cliff or resumption of risks from Europe once policy makers there return from vacation. Our equity strategists have highlighted downside risks to the equity market, now that the S&P 500 index is within striking distance of their year-end target. Another on-hold Fed meeting — or even an extension of the forward guidance when the market really wants QE3 — could be a catalyst that begets a sell-off, in our view. Look out below.


Source: BofAML

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Meesohaawnee's picture

your not going to have QE with crude at 96.. not even a discussion and why we keep beating this deader than dead horse is beyone me.

GetZeeGold's picture



Well......the horse didn't seem to mind....so we did.


davinci7_gis's picture

exactly Meesohawnee!  There won't be any QE if crude, and the market is high.  The market can hope for and forecast QE3 all it wants but the bottom line is the "actual" movement of the FED..And it won't move anytime soon.  Also, the Eurozone is going to have another collapse scare and my guess is that this is why the US market is high right now (fear of the Eurozone collapse).  Eventually, the Eurozone (Germany) is going to get so tired of bailing out Greece, Spain, etc that it will decide to create a private FED of its own...and they'll be able to print and print just like the US FED.

Quinvarius's picture

You mean they are just going to let the banks die this time?  Once you realize QE is for bankers, you will realize the inevitability of it all.  They may not name it or admit it, but QE is not stopping until the black hole is full.  That is never.  Japan has been doing it for 20 years on a lesser crisis.

Burr's 2nd Shot's picture

The turkey had no idea of why it was getting the extra food, but it was grateful for the increase, and consumed it happily.

govttrader's picture

I disagree...when the mideast is in play, crude can easily jump back up to 125...which means from current prices, there is still room for Fed action.

And with the recent Japan export implosion...flight to safety should dominate for the moment.


Cognitive Dissonance's picture

"Right now, however, we are in an anti-Goldilocks period in which the data are too hot for clear-cut Fed easing, but too cold to support a sustained rebound — anything but "just right"."

Sorry---------but the Fed's been eating our porridge for decades. What we think we see is all just an illusion.

buzzsaw99's picture

Exactly. When was the fed ever non-interventionist or laissez-faire? They steal with impunity, they live to guarantee bankster bonuses, they enforce the new york banker monopoly ruthlessly. The god complex is strong at the fed and they are NOT benevolent, fair minded, or averse to stacking the deck in their own favor.

spartan117's picture

the Fed will not launch QE3 so long as stock prices are high, yet the stock market is high because it anticipates QE3



Maybe you are just wrong.  Maybe stocks are higher because the Fed is buying equities?  Gives the appearance that no QE3 is necessary at all.  I mean, the Fed buys everything else, why not equities?

slewie the pi-rat's picture

maybe?  L0L!!!

another day, and more DISINFO abt the FED's "dual mandate" from BoAML

the FED has not had a dual mandate for OVER TWO YEARS (sonce dodd/frank passed and became the "new" BANKSTERING LAW

yogibear's picture

Maybe stocks are higher because the Fed is buying equities?

What do you think the financial institutions are doing with all that excess money? Their putting it in play in equities. The Fed doesn't directly buy, they have their member banks do that work. 

monopoly's picture

Hmmm, don't know about the Fed buying equities, thought their mandate did not allow that, but we can be assured that inflation is starting to rear its ugly head. And agree, with averages at these nose bleed levels, and gas over $4.00 here in Nevada and the drought. Yikes, unleashing another Trillion now would be suicide. But we need to keep watching Europe. If Mario gets his way he will become a clone of The Bernank, and that will move gold higher for us even if we do nothing short term.

fasTTcar's picture

Valuations too hot, Manipulation too heavy = Just wrong.

Bartanist's picture

It seems to be a short step from the Fed "targeting" prices to the Fed "controlling" individual stock prices (and thereby the indices) ... the technology and network of intermediaries certainly exist for complete control of the market.

... and it would explain some things.

edifice's picture

The Fed has achieved the Singularity, in terms of market manipulation; it no longer has to do anything--not even print money--to bouy them. The snake eating its tail (while, presumably, taking a dump).

Abraxas's picture

Snake eating its tail. I've seen that on the cover of the Protocols of the Elders of Zion.

fasTTcar's picture

Unfortunately, this story is not a myth.

Sudden Debt's picture

No QE3 but who is buying the banks stocks?


Quinvarius's picture

Whenever a Fed guy speaks about stability and no need for QE, you can be assured, he just wrote a check to someone that was much bigger than he liked.

Quinvarius's picture

So you are saying QE3 has not been going on already?  I find that point of view to be quite insane.

buzzsaw99's picture

No central banker wants to tie policy to a financial variable that itself is driven by policy expectations...

Nonsense. That is exactly what they want. They have markets trained like Pavlov's dog. If jawboning or cajoling works then they don't have to do anything for awhile.

q99x2's picture

Not maybe, the FED is part of the elite structure that is buying and positioning weapons to kill americans in the ongoing war against the US.

Bernanke is saying he will do whatever it takes to kill us.


dolph9's picture

The Fed is checkmated, there's nothing they can do.

It's beautiful to watch but painful to live through, because there's going to be alot of trauma and suffering before anybody comes out on the other end with some sort of sustainable system.

Grand Supercycle's picture

Risk off sentiment ~ SPX 8 hour bearish chart warning continues and FTSE daily chart gives bearish warning.

Of course central bank intervention could burn more shorts and reverse this scenario...