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The plunge in the Dow is result of Federal Reserve action?

by Robert Randle
02/02/18
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The Federal Reserve announced Wednesday that it would start slowly reducing the trillions of dollars in bonds it bought to stimulate the economy. the Fed has a $4.5 trillion balance sheet. With the recovery now "on a strong track," the extra stimulus from the bond purchases is no longer needed, said Janet Yellen, Federal Reserve Chairwoman.

Fed officials have been signaling for months that they planned to start reducing the Treasury bonds and mortgage-backed securities the central bank began buying in 2008.The Fed plans to gradually allow an increasing amount of proceeds from maturing securities to be run off the central bank's books each month. As the bonds mature, the government pays the face value to the Fed. The Fed would keep some of the proceeds instead of reinvesting them in new bonds. The amount of proceeds would start at $10 billion a month and increase over the course of a year until they reach $50 billion a month.

Apparently Financial markets are losing confidence in the economy and inflation fears with disappearing central bank liquidity, which may explain the precipitous drop in the stock market. In fact, four times in this week alone, bond markets have been selling off assets as long-term yields have risen; equities have sold off at the same time. The dollar has declined 14% since 2017 which increases the costs of imports and domestic goods as reflected in adjustments to the CPI. The Federal Reserve raised borrowing cost 3 times in 2017, and predicts to do the same this year. The prices for U.S. Treasuries fell with the yield on a 10-year note to a 4 year high. The labor market is almost at full employment (4.1%), so the $1.5T tax cut (over ten years) will do very little to boost job growth beyond where it is now. Wage and price pressures are factored into Bond market prices, and the Fed funds futures project 2 years out by at least 100 basis points- this means more long-term interest rate growth which depresses equities (stocks, etc.), and there has been no correction in 560 days.

"The key for the market today is rising interest rates," said Mike Baele, the managing director at U.S. Bank Wealth Management. "The old adage is: 'Bull markets don't die of old age, they are killed by higher interest rates.' That looms large." The U.S. economy added 200,000 jobs in January, according to the Bureau of Labor Statistics. Economists polled by Reuters expected growth of 180,000. Wages, meanwhile, rose 2.9 percent on an annualized basis. he report sent interest rates higher. The benchmark 10-year yield rose to 2.85 percent on the back of the report, hitting a four-year high. Investors have been jittery about the recent rise in interest rates, worrying they may be rising too fast. On Friday, the 30-year yield rose its highest level since March.

The reaction in the bond market is due to the rise in average hourly earnings. The Avg. hourly earnings rose 0.3% to $26.74 in January. Earnings are strong and the economy is doing well, but Wall Street also assessed key corporate earnings. And some companies reported weaker-than-expected earnings on Friday, sending stocks lower.

Robert Randle
776 Commerce St Apt 701
Tacoma, WA 98402
February 2, 2018
[email protected]