Futures are down modestly in early Sunday trading, and one possibility for that is the story that came out after the bell on Friday in the Wall Street Journal from Fed whisperer Jon Hilsnerath titled Fed Maps Exit From Stimulus.
The gist: The Fed is seriously thinking about how it might begin the QE winddown process.
Given the widespread belief that Fed stimulus is a major tailwind for the market, talk of QE winddown is invariably something of a negative.
In tonight’s “Closing Print” note, Mike O’Rourke from JonesTrading thinks the article’s existence is pretty significant.
The WSJ’s Jon Hilsenrath published a story Friday evening titled “Fed Maps Exit From Stimulus – Timing of Wind-Down Is Uncertain, but Focus Is on Managing Unpredictable Market Expectations.” We suspect the twitter taper caper on Thursday opened the window for the FOMC to provide some clarity as to where policy stands. Here are some key questions. Is this story important? Can it be taken at face value and should markets move? The answer is yes, yes and yes. The WSJ placed the article prominently on the cover of the Saturday edition, so they believe they have an important story. It is a Hilsenrath story, and in the post-recession QE era the Fed has used him to foreshadow almost every major monetary policy move. Finally, in a tape where QE is the dominant theme, any indication of policy slowing or reversing course is meaningful.
We think the headline in and of itself is interesting “… Focus Is on Managing Unpredictable Market Expectations.” Are market expectations really highly unpredictable? Has this Fed done anything done but promise excessive monetary support for the US economy? The market only expects what the Federal Reserve has conditioned it to expect. Nearly every time the stock market dipped over the past 3 years, a new asset purchase program was launched. We view “unpredictable market expectations” as a sign that the FOMC has been trying to foreshadow policy in one direction and the market is interpreting it in another direction.
Lest you think, however, that talk of a Fed winddown is gauranteed bad news for the market, we’d urge you to check out the latest post from Mark Dow, who argues that those expecting a meaningful fall jsut because the Fed removes the training wheels are liable to be sorely mistaken.
Again, it is important to underscore that it is the indirect psychological effects from Fed support and the low cost of capital—not the popularly imagined injection of Fed liquidity into stock markets—that have gotten investors to mobilize their idle cash from money market accounts, increase margin, and take financial risk. It is our money, not the Fed’s, that’s driving this rally. Ironically, if we all understood monetary policy better, the Fed’s policies would be working far less well. Thank God for small favours.
This is not a semantic point. I can hear traders saying “yeah, whatever, who cares, don’t fight the Fed, just buy”. But this concept has huge implications for the phase where the Fed decides to remove the training wheels. If the Fed money is not directly propping up the stock market and the economy underneath has been healing, the much talked about wedge between “Fed-induced valuations” and “the fundamentals” is likely considerably smaller than the consensus seems to think. It’s less “artificial”. In short, what all this means is the day the Fed lets up off the gas might give us a blip, or maybe that long-awaited correction, but ultimately the Policy Bears will end up getting crushed, again.