Is the Fed Stuck in a ‘Not So Merry-Go-Round?’
The Federal Reserve warns that it is on the verge of withdrawing monetary stimulus. The U.S. dollar rises; stocks fall. These tighter financial conditions darken the U.S. growth outlook. The Fed subsequently elects to stay on hold in light of the market turmoil. Markets recover as monetary stimulus is maintained, and financial conditions never really tighten persistently. Wash, rinse, repeat.
The simplified pattern describes how cynics characterize the U.S. central bank's recent relationship with financial markets.
In a note to clients, Bank of America Merrill Lynch's U.S. Economics team deemed this presumptive connection to be the "not so merry-go-round."
According to Renaissance Macro Research Head of U.S. Economics Neil Dutta, there's much more to stocks than the Fed, however. In fact, the central bank hasn't played the starring role in driving any of the biggest one-day changes in U.S. stocks over the past year, he writes.
In scouring daily Bloomberg market wrap-ups of the price action from the 20 largest moves in the S&P 500 over the past 12 months, Dutta found that the Fed was conspicuous by its omission in these headlines:
"That the Fed has not been a driver of major moves over the last year undercuts the idea that the Fed is caught in an adverse feedback loop where the threat of a hike ultimately forces them away from one via financial conditions," asserts Dutta. "The Fed is nowhere to be found in the top 20. The only policy driven market move came out of Japan."
Concerns about the global economy — in particular China — and fluctuations in the price of oil have dominated the headlines on days when U.S. stocks experienced massive swings over the past year.
To be sure, both of these themes—China and oil—have had a large U.S. monetary policy element over the past year.
The market carnage in the third quarter of 2015 came in the wake of the devaluation of the Chinese yuan. That currency's value became uncomfortably high, in the eyes of Beijing, because it was loosely pegged to the U.S. dollar. The greenback had been rising as markets looked ahead to the withdrawal of monetary stimulus by the Fed. Oil, meanwhile, is typically quoted in U.S. dollar terms—when the greenback is rallying against most currencies, crude tends to retreat.
However, if the Federal Reserve hasn't been front-and-center during even one of these major market moves over the past year, it's difficult to make the case that this reflexivity between the central bank and the markets has been the most prominent force dictating the ebbs and flows of stock prices.
Bank of America Merrill Lynch's economists, led by Ethan Harris, also pointed to this flaw in the relationship between the central bank and financial markets.
This narrative "puts the entire onus on the Fed when a lot else is going on," they conclude.