Tense Markets Await Fed Announcement

Rethinking Recent History

Many remember that the May 10 FOMC meeting marked the peak for many stock market indices. But that may have been more about Japan and the global economy than the Fed. Emerging market stocks and commodities had already begun selling-off as the risk-reduction trade was well under way.

It was Japan's threatened end of quantitative easing that sparked investors to unwind several risky trades predicated on borrowing yen at 0% to invest in other high-yielding assets around the world, says Simons. The unwinding gained steam as the Fed and other central banks raised rates in May.

"Helicopter Ben" has nothing on Japanese policymakers, who countered deflation in the 1990s by going to a 0% interest rate policy and flooding the markets with yen. In February, Japan began withdrawing 21.56 billion yen from the marketplace.

From Feb. 10 to June 12, Japan withdrew about $186.78 billion from its system based on an average exchange rate of 115.432, according to Simons. "The equivalent shrinkage in the U.S. would be a $2.272 trillion withdrawal in the money supply," he says. "Such a withdrawal in liquidity in the U.S. money supply would have a material effect."

The Nikkei has taken a beating over the past three months and the Bank of Japan recently put about 7.5 trillion yen back into the system after seeing the damage it had done. The Nikkei surged 1.6% overnight to 15,121 Thursday, helping pave the way for Wall Street's early advance.