We have heard many explanations for the torrid market rally since last September, ranging from the rational - short squeeze - to the generic - "bad news is good news under central planning" to the deranged - "ignore the news, the U.S. economy is actually stronger and China is recovering." And now, courtesy of the U.S. Treasury's Office of Financial Research, here is the official explanation from the government itself.
Shift in Monetary Policy Expectations Supports Risk Assets
Risk assets such as equities, corporate bonds, and emerging market currencies appreciated notably in October, recovering somewhat from the sharp losses in recent months. The catalyst for the rally appeared to be weaker U.S. labor market data, which delayed the expected start of monetary tightening by the Federal Reserve. Extraordinarily accommodative monetary policy has supported risk asset prices since the global financial crisis and this month’s market reaction suggests that these prices may still be contingent on accommodative policy. It remains to be seen whether current U.S. asset price ranges can be sustained once the Federal Reserve begins to raise interest rates, broadly expected to occur between December and June.
Global risk assets advanced on expectations for continued or additional accommodative policy among central banks in advanced economies
U.S. equities have rebounded strongly in October, although fundamentals remain weak. The S&P 500 index has rallied since the start of October and is up 10 percent from its August low (Figure 3). As with the broader rally in risk assets, this rebound has been attributed to the delay in an expected Federal Reserve rate hike. The rebound has occurred in the face of weaker U.S. equity fundamentals, such as the slowdown in global growth, negative effects of a stronger U.S. dollar on earnings, and continued weakness in the energy sector. For the third quarter, analysts continue to expect negative revenues and earnings for energy stocks, with modestly positive growth for non-energy S&P 500 stocks. Emerging market assets have rebounded, following months of deterioration.
Emerging market currencies have rallied since the start of October (Figure 4), led by a 5 percent to 8 percent appreciation in commodity-sensitive currencies. Emerging market equities and credit have alsoadvanced. Despite the rebound in emerging market assets, some of the recent gains also represent a technical recovery driven by covering of short positions and moderation of excessively bearish sentiment. Overall, emerging market economic fundamentals remain very weak. In its latest World Economic Outlook, the International Monetary Fund (IMF) downgraded its forecast for emerging market growth.
In summary: central banks and a "covering of short positions" better known as the fundamentals of the New Paranormal.
Don't like it? Then the following from BofA will make your blood boil:
Global weakness is OK for US markets as long as the Fed refrains from hiking rates, and vice versa it would be OK from a markets perspective for the Fed to begin hiking rates if global weakness diminishes (but not OK if US data rebounds in isolation). Hence risk assets have rallied for three weeks prompted by the turn to weaker US data that began with the weak September jobs report, as the Fed’s rate decision is understood to be completely data dependent. However, clearly for the market rally to be sustained it would be helpful if next week’s FOMC statement tilted dovish by acknowledging this turn to weaker US data.
It would be easier if they just asked the Fed to admit it will only hike if the S&P500 is at or above 2100, the VIX is below 14, and it can only do so on an uptick.