Fed Making Fundamentals Irrelevant For Markets – Saving From Disaster or Creating a Bigger One?

Fed is clearly in an overdrive these days and it is doing ‘whatever it takes’to support the markets. The Coronavirus pandemic has clearly made the US Central Bank extremely active and it began with an announcement of emergency interest rate cut in the first week of March. Now, interest rates have become almost zero and Fed is also doing big-scale asset purchases. Since 2008 when Quantitative Easing (QE) proved effective in averting a huge disaster during Global Financial Crisis (GFC), QE has become a ‘tool of choice’ for Fed.

Fed not only brings down the longer-term interest rates on mortgages and other loans remain low and helps businesses and purchasing power of customers, it also indulges in large-scale asset purchases. The interesting part is that Fed has not fixed a timeline or quantum for these purchases and hence, sending a strong signal to the markets that it won’t stop till the time the crisis gets resolved or the Fed runs out of options. As of now, the market is indicating that it is attaching a much higher probability to Fed becoming successful in its efforts.

This leads to a dichotomy here. Take a look at the Bloomberg home page (screenshot captured a while ago). While any one focusing on the big jobless claims and not looking at the second news item about Fed buying Junk and CLOs will clearly miss the big picture on the direction of the markets. How the signals from fundamentals of economy (such as jobless claims) will be interpreted and how markets will react to what Fed is doing will pull the markets in opposite directions.

Fig. 1: Bloomberg Home Page (Around 1500 Hrs GMT on 9th April 2020)

So, while the Jobless claim news report is at the top, the market is telling you that it is focusing less on that and more on other news which is that Fed is delivering on its promise. It is buying even junk and doing everything to provide the stimulus wherever it can and wherever it might be effective. Look at the S&P 500 chart for last five days and that is clear to any one following all three data points; Fed Action, Impact of Coronavirus on Fundamentals of US Economy and the direction of Markets.

Fig. 2: S&P for last five days (from Google)

There will always be questions like
a) Is Fed doing more than it should
b) Will it work this time though it may have worked in GFC
c) Is this the most efficient method
d) Is Fed ignoring the long term consequences of its actions, and
e) Will the ammunition last till the time Corona keep impacting the economy?

Of course, these will be valid questions and the views will be subjective on many of these issues. It is right or wrong what Fed is currently doing, that will be the discussion for some other day. But at least for the time being, the markets are telling you that what Fed is doing, is working. And it is working really well so far!

Research Team
EM Alpha LLC

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EMAlpha, a data analytics and investment management firm focused on making Emerging Markets (EMs) accessible to global investors and unlocking EM investing using machines. EMAlpha’s focus is on Unstructured Data as the EMs are particularly susceptible to swings in news flow driven investor sentiment. We use thoroughly researched machine learning tools to track evolving sentiment specifically towards EMs and EMAlpha pays special attention to the timely measurement of news sentiment for investors as these markets can be finicky and sentiment can be capricious.Our team members have deep expertise in research and trading in multiple Emerging Markets and EMAlpha’s collaborative approach to combining machine learning tools with a fundamental approach help us understand these markets better.

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