Aside
from the fact that the 10-Year Treasury Yield Index (TNX) is rising, another
reason for the latest equity market sell-off is the uncertainty generated by
the Fed’s recent announcement.
At its
latest press conference, Fed Chairman Bernanke indicated the central bank could
start winding down its $85 billion/month asset purchase program known as QE3 as
soon as next month. This has
understandably caused a certain amount of consternation on Wall Street,
especially given the feeling among many traders that QE has been largely
responsible for the stock market’s rebound.
What
many investors don’t realize is that the Fed’s monetary stance has already
tightened even before the “tapering” begins.
Author Ramesh Ponnuru, in his National
Review article entitled “Cause for Depression,” points out that by merely
telegraphing its intentions, the Fed creates expectations for future money
conditions. This in turn reverberates
through the financial system well ahead of actual changes in Fed money
policy.
“When the Fed creates an
impression about future spending levels,” writes Ponnuru, “it affects the
spending that people undertake today in anticipation of that future. So when the Fed suggests that it will pursue
a tighter money policy in the future, it is effectively tightening money in the
present. Even when it cuts the federal-funds
rate, it may be tightening money if markets had projected a sharper cut.”
Ponnuru
went on to define tight money as “reduced expectations of future
spending.” That’s as concise and as
practical a definition of tight money as you’ll hear. His explanation of future expectations for
money conditions fully explains what’s happening right now with the bond market
and the stock market.
