Friday, May 13, 2016

If The Fed Follows Stocks, They'd Better Be Careful

If the Fed is guided by the stock market as suggested below, then it (the Fed) must assume that stock's trend follows economic activity. Unfortunately, this is not always the case. The stock market can rally if confidence in the public sector crashes unexpected. The brute force of safe haven capital flows, the flow of money from periphery economies and the public sector (previous cycles safe havens), can force stocks higher despite liquidation. Panics, driven by risk-aversion (fear) rather risk-taking (greed), can force highly-liquid stocks to unbelievable valuations (see Review of Dividend Yields). A myopic Fed that derives policy from the direction of stocks will make a lot of policy mistakes during panics.

Headline: UBS: The stock market guides the Fed

The Federal Reserve's monetary policy is guided by a dual mandate: to achieve maximum employment and stable prices.

So, it can be a bit conspiratorial to suggest that the Fed will react to swings in the stock market.

But according to new research from UBS, the stock market is a bigger driver of the path of monetary policy than changes in payrolls or expectations for prices. They came to this conclusion by observing how various economic and market variables moved with the Fed dots, which represent the Fed's expectation for future interest rates.



Market-driven money flow, trend, and intermarket analysis is provided by an Insights key.