MORGAN STANLEY: 'It's The Fed, Stupid'

There continues to be two schools of thought on what’s been driving the global financial markets.

One school believes that it has been all about global central banks, who have caused massive distortions by flooding the markets with cash, inflating the bond and stock markets.

The other school believes central banks have played a more indirect roll. They believe markets have been driven largely by economic fundamentals. In the U.S., easy monetary policy from the Fed has helped stimulate the economy, which in turn has encourage investors to fuel the rally in stocks.

In a new note to clients, Morgan Stanley’s Hans Redeker reminds us that his firm is strictly in the former camp.

It’s the Fed, stupid. Core equity markets eased last week. Worryingly, in the US the ratio of shares falling below their 200-day MA relative to those trading above the 200- day MA has fallen rapidly, suggesting that the share market is fading. Rising bond yields accompanied by simultaneously falling equity prices is a rare event, but should be expected when the Fed starts reducing its liquidity injections in September. The Fed’s QE policy, in place since March 2009, first aims to increase the asset to liability ratio in the economy in order to ease credit restrictions via asset valuations, and second aims to initiate portfolio shifts into higher-yielding asset classes. Now, as the Fed signals a shift in its approach, asset markets have to price in a higher risk profile.

The S&P 500 fell last week, closing Friday at 1,655. Just two weeks ago, it closed at an all-time high of 1,709.

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