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Why Markets Shrugged-off the Fed`s Major Stimulus Package and Failed to Rally?

Publish Date14/12/2012 12:34:21 PM

Last Update14/12/2012 03:34:34 PM

Why Markets Shrugged-off the Fed`s Major Stimulus Package and Failed to Rally?

Different theories, explanations either sensible or not were spread over why risk-correlated currencies, indices and gold were under pressure following the Federal Reserve announcement of a fresh $45 billion of new long term treasury purchases, boosting its asset purchase program to $85 billion a month, expanding its balance sheet of over a trillion if the program extends for one year; what if the economy doesn`t not improve is it going to continue pumping a trillion every year!

Shouldn`t gold, silver rally after this “inflation dose”, why high yielding currencies such as the Australian dollar failed to impress as well, not to mention U.S. equities which moved lower ever since.

Some claim that the sell-off was just “buy the rumor sell the fact” story, however this seems an easy explanation for a complicated or uneasy situation of market conditions; I will explain why in a minute. Some believed the fiscal cliff uncertainty is the major drag for markets and dampened risk-appetite.

No one can claim having a decisive conclusive explanation, however assessing the facts, and examining different asset classes performance following the announcement; we notice that tight monetary policy sensitive instruments such as precious metals, higher yielding currencies and equities retreated, in addition to U.S. bonds; while, the euro and oil -more growth sensitive commodity- looked a bit more resilient.

Having said that, the risk aversion scenario seems a bit unconvincing here, as growth commodities are more reluctant to fall, in addition to global equities. This indicates the fiscal cliff uncertainty scenario has less weight in the equation. Especially that U.S. equity markets have been rallying since mid November, despite U.S. officials` rhetoric over the lack of progress in negotiations, why would investors react to the fiscal cliff suddenly and precisely after the FOMC decision!

Nevertheless, it may be a combination of these factors that resulted in no rally; however the most important one I believe is the major shift in how investors would interact with markets following the unprecedented move from the FED to tie interest rates tightening to 6.5% unemployment rate threshold.

The Federal Reserve claimed that it’s being more transparent by providing markets their own way in assessing the appropriate monetary stance through economic developments. However, at first glance, it’s not the case, as markets looks hesitant, and by giving this target, the FED added another layer of uncertainty and left markets exposed to investors’ views which may not be in line with the FED’s, and eventually may backfire.

If I was an investor, and believed that the economy would grow at a faster pace than the Federal Reserve forecasts, that would lead me to position myself accordingly, and may lead to unanticipated and undesirable outcomes that may result in premature retraction from equities and bonds, pushing interest rates higher, which if not in the right time may lead to undesirable consequences to an already sluggish recovery.

Anyhow, the latest package of stimulus is huge, and should continue to support risky assets and form a net below markets; however, sharp volatility may be the new norm as markets adjust to every signal fresh economic report. I expect any positive development over the fiscal cliff would unleash a major bullish rally in equities and risk-correlated currencies, and of-course gold.


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