Weekend Reading: Markets Love Central Banks – No Matter What They Do

I discussed yesterday, the apparent “myth” of the Fed’s proposed “balance sheet reduction” program as the most recent analysis shows a $13.5 billion “reinvestment” into their balance sheet which has helped fuel the recent market advance.

But therein lies the potential “fatal flaw” of the “bullish logic.”

At the September FOMC meeting, the Federal Reserve announced their latest decision which contained two primary components:

No rate hike currently, although, further rate hikes are likely in the future, and;

The beginning of the process to cease reinvestment of the Fed’s balance sheet.

That announcement was notable for two reasons:

The Fed did NOT hike rates because the underlying economic data, and, in particular, the inflation data, suggests the economy is too weak to absorb a further increase currently, and;

The unwinding of the balance sheet is generally believed to be bullish for stocks.

So, despite the clear evidence of the support for the markets provided by near zero-interest rate policy and trillions in monetary injection, it is believed that “unwinding” those supports will have “no effect” on the market. In other words, it doesn’t matter what the Fed does, it’s “bullish.”

The same is also believed to be the case for the European Central Bank and Mario Draghi who just announced yesterday that the ECB’s QE program will begin to be reduced by €30 Billion per month (down from €60 Billion).While this will continue the expansion of their balance sheet currently, the end of “QE,” as the markets have come to know it, is coming to an end.

Don’t misunderstand me, Central Banks are still very actively engaged in the support of the financial markets for the time being which keeps asset prices positively buoyed. However, with Central Banks now “tightening” monetary policy, the risk of a policy error has risen markedly. This is particularly the case when the financial markets insist on ignoring the knock-off effects of less liquidity.