By Murray Gunn
For better or worse, the markets perceive that Fed chairman Powell has showed his hand.
The recent Federal Open Markets Committee (FOMC) minutes of the January meeting revealed almost unanimous agreement to announce a plan soon for ending the Fed’s policy of balance sheet reduction. This is the first step in an inevitable march toward the fourth round of quantitative easing (QE4).
If any more evidence were needed pointing to the fact that Fed policy is led by the markets, this surely is the icing on the cake. Stock markets tumble in the fourth quarter and, in January, not only does the Fed signal a reversal in its interest rate path, but the FOMC members have a collective buttock clench over its policy of reducing the trillions of dollars of new money created after the financial crisis of 2008. Music to conventional analysts’ ears. The “Powell Put” is in place. From this moment on, whenever stock markets fall, the buy-the-dippers will be full of confidence thinking that the Fed will come to the rescue.
And therein lies the problem.
You see, it’s all about causality. Or more succinctly, the perception of causality. Most market participants think that the stock market rally since December has been caused by the reversal in Fed policy. Not so. It was the decline in stock markets during the fourth quarter that caused the Fed’s U-turn. FOMC members are human. They have emotions. They herd, just like the rest of us.
The Socionomic Theory of Finance noted QE’s impotence with respect to moving market prices. Chapter 2 (read an excerpt here) shows that stocks did not respond commensurately to the Fed’s quantitative easing program. And forget about commodities. In July 2008, just two months before the onset of QE, commodity prices started their biggest bear market since 1932. As the author Robert Prechter noted, “Anyone applying exogenous-cause thinking to these data would have to conclude that QE worsened the collapse in commodity prices.”
Nevertheless, the fairytale of central bank policy dictating how financial markets and the economy perform persists. This will last until that ephemeral thing called confidence ceases to exist. In the next downturn, or the next, when QE4 is seen to make no difference whatsoever, at that point the market’s perception of the omnipotent Fed will falter. When it does, when markets come to the realization that the Fed is not the “secret sauce” that keeps stock markets going up, the fallout will be cataclysmic.
About Murray Gunn
Murray Gunn is Head of Research for Elliott Wave International’s Global Market Perspective, a monthly summary of the firm’s 25 analysts’ views on every major freely-traded market in the world. After earning his Master of Arts (Honors) degree in Economics from the University of Dundee in Scotland in 1991, Gunn went into fund management. He quickly realized that textbook descriptions don’t apply to real-world markets, which in turn led him to technical analysis and the Elliott Wave Principle. He worked as a fund manager in global bonds, currencies and stocks, including long posts at Standard Life (LON:SLA) Investments and a five-year stint in the Middle East at the Abu Dhabi Investment Authority. Gunn then joined HSBC as Head of Technical Analysis. He has served on the board of the Society of Technical Analysts and delivered lectures on the Elliott Wave Principle to students at The London School of Economics, Queen Mary University and Kings College London. You can read Gunn’s commentary in Elliott Wave International’s Global Market Perspective, Interest Rates and Currency Pro Services, and on deflation.com.