FacebookTwitterGoogle+RedditEmail

The Fed’s Role in the Stock Market Slide

by

shutterstock_177561374

When the Dow Jones Industrial Average (DJIA) and S&P peaked in May 2015, investors were still confident that the Fed “had their back” and that any steep or prolonged downturn in stocks would be met with additional liquidity and a firm commitment to maintain zero rates as long as necessary.  But now that the Fed has started its long-awaited rate-hike cycle, investors aren’t sure what to expect.

This growing uncertainty coupled with flagging earnings reports have factored heavily in Wall Street’s recent selloff. Unless the Fed is able to restore confidence by promising to take steps that support the markets,  stocks are going to continue get hammered by economic data that’s bound to deteriorate as 2016 drags on.

For the last few years, investors have relied on the so called “Bernanke Put” to prevent significant stock losses while the real economy continued to sputter and underperform.  The moniker refers to the way the Fed adds liquidity to the markets during periods of stress to put a floor under stocks. Investors have been so confident in this safety-net system that they’ve dumped trillions of dollars into equities even though underlying fundamentals have remained weak and the economy has sputtered along at an anemic 2 percent per year. Investors believed  the Central Bank could move stocks higher, and they were right.

The Dow Jones has more than doubled since it touched bottom on March 9, 2009 while the S&P soared to a new-high (2,130 points) on May 21, 2015, tripling its value at the fastest pace on record. These extraordinary gains are the direct result of the Fed’s not-so-invisible hand in the financial markets. Betting on the Fed’s ability to move markets higher has clearly been a winning strategy.

So why are stocks crashing now?

Because everything has changed.  Up to now, “bad news has been good news and good news has been bad news”. In other words, for the last few years, every time the economic data worsened and the media reported flagging retail sales, bulging business inventories, shrinking industrial production, anemic consumer credit, droopy GDP or even trouble in China–stocks would rally as investors assumed the Fed would intensify its easy money policies.

Conversely, when reports showed the economy was gradually gaining momentum,  stocks would drop in anticipation of an early end to the zero rates and QE.  This is how the Fed reversed traditional investor behavior and turned the market on its head. Stock prices no longer had anything to do with earnings potential or prospects for future growth; they were entirely determined by the availability of cheap money and infinite liquidity. In other words, the market system which, in essence, is a pricing mechanism that adjusts according to normal supply-demand dynamics–ceased to exist.

This topsy-turvy “good is bad, bad is good” system lasted for the better part of six years buoying stocks to new highs while bubbles emerged everywhere across the financial spectrum and while corporate bosses engaged in all manner of risky behavior like stock buybacks which presently exceed $4 trillion.

The Fed’s commitment to begin a cycle of rate hikes (aka–“normalization”) threatens to throw the financial markets into reverse which will slash stock prices to levels that reflect their true market value absent the Fed’s support. The question is: How low will they go?  No one really knows the answer, but given the sharp slide in corporate earnings, the stormy conditions in the emerging markets, the unprecedented decline in oil prices, and the buildup of deflationary pressures in the global economy; the bottom could be a long way off.

One thing is certain, the Fed will do everything in its power to prevent stocks from dropping to their March 2009-lows. Unfortunately,   further meddling could be extremely risky which might explain why the Fed has not yet responded to the recent equities-plunge. As I see it, the greatest risks to the system fall into three main categories:

1) Asset bubbles

2) Danger to the US Dollar

3) Threat to US Treasuries market

It could be that the Fed is afraid that any additional easing will burst the bubble in stocks and bonds triggering a wave of defaults that could lead to another financial crisis. Or it could be that another round of QE (QE4?) could weaken the dollar at the precise moment that foreign rivals are threatening to topple the USD as the world’s reserve currency which would greatly undermine Washington’s global power and prestige.

Or it could be that more easing could constrict the flow of foreign capital into UST’s. With petrodollar recycling at its lowest ebb in three decades and China already selling its cache of Treasuries to prop up its currency, a significant selloff of US debt could raise long-term interest rates sharply pushing the US economy deep into recession and forcing fiscal cutbacks that would leave the economy in the doldrums for years to come.

Whatever danger the Fed sees on the horizon, it’s clear that the road to normalization is going to involve more than a few speed-bumps along the way. As for stocks; the extreme volatility and downward movement can be expected to intensify as the markets shake off seven years of rate-suppression and monetary “pump priming”.

And while its still too early to know whether the recent turbulence signals the onset of another financial crisis, it certainly appears that Wall Street and the Fed are edging ever closer to their inevitable day of reckoning.

MIKE WHITNEY lives in Washington state. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion (AK Press). Hopeless is also available in a Kindle edition. He can be reached at fergiewhitney@msn.com.

More articles by:

CounterPunch Magazine

minimag-edit

bernie-the-sandernistas-cover-344x550

zen economics

Weekend Edition
December 02, 2016
Friday - Sunday
John Pilger
The Coming War on China
Jeffrey St. Clair
Roaming Charges: The CIA’s Plots to Kill Castro
Paul Street
The Iron Heel at Home: Force Matters
Pam Martens - Russ Martens
Timberg’s Tale: Washington Post Reporter Spreads Blacklist of Independent Journalist Sites
Andrew Levine
Must We Now Rethink the Hillary Question? Absolutely, Not
Joshua Frank
CounterPunch as Russian Propagandists: the Washington Post’s Shallow Smear
David Rosen
The Return of HUAC?
Rob Urie
Race and Class in Trump’s America
Patrick Cockburn
Why Everything You’ve Read About Syria and Iraq Could be Wrong
Caroline Hurley
Anatomy of a Nationalist
Ayesha Khan
A Muslim Woman’s Reflections on Trump’s Misogyny
Michael Hudson – Steve Keen
Rebel Economists on the Historical Path to a Global Recovery
Russell Mokhiber
Sanders Single Payer and Death by Democrat
Roger Harris
The Triumph of Trump and the Specter of Fascism
Steve Horn
Donald Trump’s Swamp: Meet Ten Potential Energy and Climate Cabinet Picks and the Pickers
Louis Proyect
Deepening Contradictions: Identity Politics and Steelworkers
Ralph Nader
Trump and His Betraying Makeover
Stephen Kimber
The Media’s Abysmal Coverage of Castro’s Death
Dan Bacher
WSPA: The West’s Most Powerful Corporate Lobbying Group
Nile Bowie
Will Trump backpedal on the Trans-Pacific Partnership?
Ron Ridenour
Fidel’s Death Brings Forth Great and Sad Memories
Missy Comley Beattie
By Invitation Only
Fred Gardner
Sword of Damocles: Pot Partisans Fear Trump’s DOJ
Renee Parsons
Obama and Propornot
Dean Baker
Cash and Carrier: Trump and Pence Put on a Show
Jack Rasmus
Taming Trump: From Faux Left to Faux Right Populism
Ron Jacobs
Selling Racism—A Lesson From Pretoria
Julian Vigo
The Hijos of Buenos Aires:  When Identity is Political
Subcomandante Insurgente Galeano
By Way of Prologue: On How We Arrived at the Watchtower and What We Saw from There
Dave Lindorff
Is Trump’s Idea To Fix the ‘Rigged System’ by Appointing Crooks Who’ve Played It?
Aidan O'Brien
Fidel and Spain: A Tale of Right and Wrong
Carol Dansereau
Stop Groveling! How to Thwart Trump and Save the World
Kim Nicolini
Moonlight, The Movie
Evan Jones
Behind GE’s Takeover of Alstom Energy
James A Haught
White Evangelicals are Fading, Powerful, Baffling
Barbara Moroncini
Protests and Their Others
Joseph Natoli
The Winds at Their Backs
Cesar Chelala
Poverty is Not Only an Ignored Word
David Swanson
75 Years of Pearl Harbor Lies
Alex Jensen
The Great Deceleration
Nyla Ali Khan
When Faith is the Legacy of One’s Upbringing
Gilbert Mercier
Trump Win: Paradigm Shift or Status Quo?
Stephen Martin
From ‘Too Big to Fail’ to ‘Too Big to Lie’: the End Game of Corporatist Globalization.
Charles R. Larson
Review: Emma Jane Kirby’s “The Optician of Lampedusa”
David Yearsley
Haydn Seek With Hsu
FacebookTwitterGoogle+RedditEmail