The Fed's 'Bizarro' World
The Bizarro World
David Patterson of Brandywine Trust Group, in an Aug. 15 piece in the The Wall Street Journal, opined that markets no longer move on fundamental economic data, but on anticipated Fed policy moves. In fact, it isn't so much the policy change itself that moves the markets, but whether or not that change was more or less than anticipated (i.e., the second derivative).
Patterson's premise is that the market knows that the Fed is counting on the "wealth effect," via a rise in equity prices, to have an impact on consumption, and anticipates and discounts Fed actions to achieve that "wealth effect." If the Fed acts (or fails to act), and its actions (or lack thereof) disappoint market expectations, equity prices react negatively. As a result, because "good" fundamental economic data means a stronger economy and less need for monetary accommodation, we now have the bizarre world where "bad" fundamental economic news moves the markets higher, while "good" news does the opposite. That is, "bad" is now "good," and "good" is "bad." Patterson sums up the Fed's Bizarro World as follows:
"The process can at some point turn powerfully negative, if the monetary stimulus stops, or is expected to stop, or becomes ineffective, which it will if it is expected to become ineffective, because it is only effective based on what the market expects."
There are no special attributes of wisdom that are automatically imparted to the Fed's chair at his/her swearing-in ceremony. The nontraditional policies adopted by the Bernanke Fed, and mimicked by other major central banks, are experimental.Going in, they did not know what the unintended consequences would be. But now we are getting a glimpse. At this writing, we do not know how the Fed's September decision about the "tapering" of its QE program will impact the equity markets. Will it disappoint, or not? But, what we do know is that in the Fed's new bizarro world, whatever that decision may be, and whether it disappoints market expectations, market reaction will not be tied to economic reality. This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
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