Fed’s Repo Response Isn’t Fueling the Stock Market

During the past few months, the U.S. stock market has surged as the the Federal Reserve bought hundreds of billions dollars of Treasury bills to add reserves to the banking system and calm the repo market. Are the two connected? Or is the stock market going up for other reasons? The answer is important because the Fed’s large T-bill purchases will end soon. If the central bank’s balance-sheet expansion is truly lifting stocks, then the market is vulnerable when these purchases cease.

I am skeptical that the Fed’s balance-sheet expansion is having a major effect on U.S. stock prices. First, of course, correlation isn't the same as causation. Just because two things are moving together doesn’t mean that one causes the other. Second, and more importantly, the notion that the Fed’s actions are fueling a stock market bubble isn’t supported by how the Fed’s T-bill purchases are affecting short-term interest rates or how the Fed’s actions are increasing liquidity in the financial system. Third, there is a more obvious explanation behind the stock market’s rise: the prospect of a sustained economic expansion and a Fed that is likely to stay on the sidelines and not raise its federal funds rate target in 2020.