Is Fed Easing No Longer Working?

After starting to bounce the prior week, the S&P500 resumed its decline last week. While not falling by a lot (only about 0.2%) the S&P failed to extend its rally off the lows reached in late August. Volume was a bit higher than it was the prior week when stocks rebounded. But volatility slumped back a bit, with the VIX index dipping back down to the lower 20’s. That said, the VIX index remained far more elevated than it’s been for the last three years—in other words, while prices have not dropped all that much from peak, investors remain very nervous about the potential for more downside movement.

On the technical front, two things stand out on the charts. First, the bounce off the August lows is still in effect, despite the slight retreat last week. For this bounce to fail officially, stocks would have to continue dropping this upcoming week, and by much more than only 0.2%. Second, on the weekly charts, the breakdown that got underway in August is still fully in effect. S&P prices as of Friday were still bell below both their 200 and 50 day moving averages. And more importantly, the 200 day moving average is still sloping downward. As mentioned here repeatedly over the last couple of years, both these developments are very bearish for the stock market, especially over medium term….despite the somewhat bullish bounce visible on the daily charts over the near term.

On the economic front, the reports last week were mostly disappointing. Retail sales missed, and more importantly, retail sales ex-autos also missed. The Empire State manufacturing survey again reported an abysmally low number, instead of rebounding as expected. Industrial production missed. Consumer prices came in below consensus estimates. Housing starts missed. The Philly Fed outlook collapsed, registering a 31 month low. For the week, only initial jobless claims came in slightly better than expected.

So the big news last week as the Fed announcement….specifically that the Fed would not raise interest rates, off the zero level, in September as many economists had predicted that they would do. The two major reactions were–First, what does the Fed know that’s so bad about the US economy that 9 years after last raising rates, they determined that it would be too risky to raise them by a mere 0.25%?  While the Fed did not point to one specific reason or risk, the consensus among most analysts was that the US economic situation is still too fragile to endure even a tiny rate increase. This is not a positive signal from the Fed. The second major reaction was very surprising. By not raising rates, the Fed was implicitly more dovish or accommodating to the financial markets, and over the past 6-7 years, whenever the Fed signaled more accommodation, risk asset markets rallied. But this time, the opposite happened. Instead of rallying, the US stock market for example, fell back. And this raises an important question—-is the Fed’s policy of accommodation no longer having a positive effect on markets?  Because if so, this would be a sea-change in terms of how markets react to Fed policy. And more importantly, it would portend a very negative outlook for US stocks. It would mean that for the first time in years, Fed easing would not work to prop up stock prices. Remember, the Fed was easing all the way from the beginning of the 2007-2009 stock market decline, so stocks can and do fall despite easing.

Could this mean that something similar is now happening….for the first time since 2007-2009?


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