We’re finally here. About 9 years after QE1 began, QT is about to start. If one believes that the stock market still is a discounting mechanism, then have nothing to fear with QT and that maybe it will actually be like ‘watching paint dry’ as Fed members so desperately want it to be. After all, the S&P 500 is at an all-time high. If you think, like me, that the stock market is not the same discounting tool as it once was because of the major distortion and manipulation of markets via central market involvement and the dominance of machines that are reactive instead of proactive in response to news, then we must review again the previous experiences when major Fed changes took place. After all, they were all well telegraphed as this week’s likely news has been.
Before I get to that, let me remind everyone that the 3rd mandate of QE was higher stock prices. Ben Bernanke in rationalizing the initiation of QE2 in a Washington Post editorial back in November 2010 said in regards to QE1 and the verbal preparation for QE2: ‘this approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action.’ He then went on to say ‘higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.’ Yes, the belief in the wealth effect which hasn’t worked in this expansion. Hence, the record high in stocks last week and the 2.9% y/o/y rise in core August retail sales, both below the 5-year average and well less than the average seen in the prior two expansions.
This post was published at FinancialSense on 09/18/2017.