A mixed message

Equity markets appear to remain in a state of flux as last night the Federal Reserve confirmed the winding up of their bond purchase program. Despite a rally in the dollar, the headline announcement was met with a muted response in the US, as the S&P 500 closed little changed on the day.  Overnight on Wednesday Asian markets were mostly in the blue. This led to a solid start to the day in Europe boosted by what appeared to be a reasonable set of company earnings reports. The economic data from Europe was generally no worse than expected, even if those expectations were pretty low.

 

There has been criticism in the past that the Fed and the Bank of England have been guilty at times of giving mixed messages on the timing of the first rate rise. After last night’s statement, on this occasion at least, this criticism would seem fair.

 

It was not more than a couple of weeks ago equity markets were gripped with fear over a countless selection of issues, and at that point Fed officials were quickly wheeled out to assure investors that the Federal Reserve remained fully supportive. On the back of these comments speculation increased the Fed may extend the timing of the bond purchase program. Interest rate rise expectations were pushed out further, possibly beyond the middle of next year.

 

It would appear as investor fear has calmed in the past week, so has the Federal Reserves view on the economic outlook. Equity markets drifted lower during the morning as investors focused on the more hawkish comments in last night’s press statement. Delivering an encouraging message about the state of the US economy, even pointing to some pick up in capacity utilisation. On inflation the Fed expressed the view that in the short term inflation will remain subdued, helped by the lower oil prices, but longer-term inflation expectations have remained stable. Equity investors like uncertainty less than anything else and overnight that appears to be what the Fed has managed to create.

 

Whether the Federal Reserve had advanced notice of Thursday’s GDP report showing that the economy in the third quarter grew ahead of expectations at 3.5% year on year, and this influenced their press statement, one can only speculate. The reality probably remains that the Fed are still not prepared to take any risks with the economic recovery and will stand behind markets for the foreseeable future, as the economy continues to recover in a gentle but sustainable manner. 

Posted on October 30, 2014 .