Ed note: We first published this yesterday, but given that the Fed’s two-day meeting begins today, and since the Fed is all anyone is going to be talking about, we thought it was worth re-mentioning.There’s tons of hype about this week’s big two-day Fed meeting, but really, nobody expects much real impact on anything.
Certainly the markets are pretty subdued about the prospects of a Fed that buys more long-term debt, while selling the short end of the curve.
BofA/ML weighs the evidence:
The equity market doesn’t perceive it to be as effective: Although normally positive, the correlation between rates and stocks typically turns negative in anticipation of Fed easing. Lower rates (pricing in additional demand) and higher equities (portfolio-balance channel) have been a sign of pricing in increased Fed accommodation, historically. As a result, the rates- stocks correlation usually turns negative when the market is focused on the next Fed step… However, this time around the correlation is still at 70%.This can be attributed to one of two factors – 1) The market is pricing in that policy action this time around will not effective in stimulating growth, unlike QE2 was perceived to be. 2) The equity market is not pricing in any further accommodation, which is unlikely given the repeated mentioning of this policy tool by FOMC members, including Chairman Ben Bernanke and the minutes of the Aug FOMC meeting.
Inflation expectations have not risen: Inflation expectations, as reflected by 10y TIPS breakevens have in fact declined over the last few weeks, though we think the market has priced in an increasing probability of additional monetary easing. This is unlike QE2, when breakevens increased nearly 100bp from their lows in August… if OT was perceived as being effective in providing a boost to the economy, arguably inflation expectations would not have declined. This argues that the market does not perceive OT as being as effective.
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