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Is the FOMC Playing the Stock Market?

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Technical analysis and fundamental analysis point to purchase by the Fed of equities. Those being circumstantial evidences it sounded like a conspiracy theory. Now we received an insider view that says it is actually happening.

Technical: some have noticed that the long range bound behavior of the market (SP500 in 1040-1232 range with a ferocious defense of 10,000 support on DJIA). However when mimicking the regular market behavior the intervention forgot the Hindenburg Omen.

Fundamental: while the long-term yields were indicating an extremely week economy the stock indices kept their trading range. This disconnect between fixed rates and equities have been even stronger lately. This could only be explained by Quantitative Easing in conjunction with some stock purchase by the Federal Reserve System.

On september 15th Alan Greenspan gave us his view on that phenomenon:

Greenspan Says Fiscal Stimulus Has Been Less Effective Than Anticipated (Bloomberg)

Greenspan said the "most effective" stimulus would be an increase in stock prices rather than more government spending. "We have to find a way to settle down the extent of activism that is currently going on and allow this economy to heal," Greenspan said. "We would be far better off to allow the normal market forces to operate." "There is a heavy weight of uncertainty on the system such that we are not getting the impact of a trillion dollars already on the books into the marketplace," he said, describing the situation as a "liquidity trap."

He said once that this low unsustainable long-term yields, an interest risk premium spread, will have an important impact on both financial markets and economy:

Thus, this vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent. To some extent, those higher values may be reflecting the increased flexibility and resilience of our economy. But what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums.

But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy? We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy. But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy.

We know that following crashes there have been in the past intervention. The public knows about one successful occurrence in 1907, when John Pierpont Morgan, Sr. successfully rescued the stock market of J.P. Morgan & Co. but he does not remember a resounding failure after Black Thursday in 1929.

What does Chairman Ben S. Bernanke have to say?

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He said in Japanese Monetary Policy: A Case of Self-Induced Paralysis?:

"Among the more important monetary-policy mistakes were

1) the failure to tighten policy during 1987-89, despite evidence of growing inflationary pressures, a failure that contributed to the development of the "bubble economy";

2) the apparent attempt to "prick" the stock market bubble in 1989-91, which helped to induce an asset-price crash;

and 3) the failure to ease adequately during the 1991-94 period, as asset prices, the banking system, and the economy declined precipitously.

Bernanke and Gertler (1999) argue that if the Japanese monetary policy after 1985 had focused on stabilizing aggregate demand and inflation, rather than being distracted by the exchange rate or asset prices, the results would have been much better.

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I will argue here that, to the contrary, there is much that the Bank of Japan, in cooperation with other government agencies, could do to help promote economic recovery in Japan.

Most of my arguments will not be new to the policy board and staff of the BOJ, which of course has discussed these questions extensively. However, their responses, when not confused or inconsistent, have generally relied on various technical or legal objections- objections which, I will argue, could be overcome if the will to do so existed."

The illegality of such actions is considered by Chairman Ben S. Bernanke as simple technical or legal objections that can be overcome by the will to do so.. These illegal behaviors are bound to end with the disclosure of the Fed's balance sheet:
Fed Loses Bid for Review of Disclosure Ruling on U.S. Bank Bailout Records.

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The FOMC is Playing the Stock Market!

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I have an engineer diploma from Ecole Centrale de Lyon (France) and a MBA from Boston University. Since 1986 till 1994 I have worked as a broker dealer on the French Domestic Fixed interest market. Since the spring of 1994 I have worked on the (more...)

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[[TARP]][[BAIL]]... by Shalom Hamou on Friday, Sep 17, 2010 at 4:29:20 PM