The Fed has announced three important things today:
1. Acceleration of QE. The Fed will stop "twisting" - i.e. sale of short-dated Treasuries and buying long-term Treasuries - and double down on QE by engaging in net new Treasury purchases of $45 billion per month.
2. Commitment to reducing unemployment made clearer and stronger. By promising to maintain strong monetary accommodation until unemployment falls below 6.5%, the Fed has made its commitment to reducing unemployment more unambiguous. Reducing this ambiguity plausibly strengthens the effectiveness of the Fed's commitment since financial and economic actors will have no reason to engage in potentially deleterious speculation about the possibility of the Fed prematurely withdrawing monetary support (unless inflation rises above 2.5%).
3. Slightly eased commitment to containing inflation. In past years, the Fed has consistently emphasized that inflation of 2.0% was within its "comfort zone." The Fed has now "fudged" this goal a little bit by announcing that 2.0% is merely a "long-run" goal and that a 2.5% inflation rate would still be consistent with this long-run goal. This essentially gives the Fed a bit more "wiggle room" to maintain policy accommodation in the face of accelerating inflation.
I believe that today's announcements are significantly bullish for equities in the short to medium run for two main reasons.
First, I believe the Fed's new policy of conditioning accommodation to publicly announced goals contributes to short and medium term financial stability since the need for market participants to guess about what the Fed's next move will be has been significantly diminished. On the margin, this should contribute to lowering risk premiums across financial markets, including equity risk premiums. On the margin, this is supportive of PE multiple expansion.
Second, the Fed is accelerating "portfolio effects" whereby Fed purchases of "safe" assets forces investors into "riskier" assets. On the margin, this tendency favors equities as the demand for equities is increased beyond what it would otherwise be.
Having said all of the above, I am skeptical about the short and medium run economic effectiveness of the current set of Fed policies. The reason is simple: There is ample evidence to suggest that economic growth is not being significantly constrained by either lack of liquidity or because interest rates are too high. While increasing liquidity and repressing interest rates can help economic activity at the margin, it is my view that the benefits of these extraordinary measures under the current set of economic conditions are vanishingly small.
By contrast, if we focus on long-run effects, it is my view that the Fed's extraordinary policies of financial repression may have significant negative effects for long-run economic growth and economic stability in the future. By artificially repressing yields to such a large extent, and by driving portfolio shifts towards riskier assets to such a large degree, the Fed is setting up a situation in which the normalization of interest rates in the future could be relatively traumatic for the economy and financial markets, thereby leading to higher levels of financial and economic volatility and lower levels of long-run economic growth.
Thus, it is my view that for the economy at large, the short-term benefits of the Fed's extraordinarily loose set of monetary policies are excessively small compared to the long-term costs and risks to the economy being assumed which may be substantial.
For reasons more fully detailed in a previous article, it is my view that insofar as the US economy is not liquidity constrained, the current level of financial repression by the Fed may well do more harm than good in the long-run. However, readers should not misunderstand me: I do not think that current Fed policy is going to cause high inflation any time soon. My view is that current Fed policy jeopardizes future growth and stability by making interest rate normalization more painful. Furthermore, it is my view that given the major uncertainties associated with the Fed's massive balance sheet expansion - and in particular the Fed's ability to exit from this state of affairs seamlessly - current Fed policy incrementally erodes the credibility of the Fed's commitment to low and stable inflation.
There are many factors that influence stock prices and Fed policy is only one of those factors. However, if Fed policy were all that mattered, today's announcements by the Fed would have to be viewed bullishly, and stocks such as Apple (AAPL), Cisco (CSCO) and Intel (INTC) and broad index ETFs such as (SPY), (DIA) and (QQQ) would be expected to benefit as a result.
However, Fed policy is not the only variable that matters. Therefore, it is necessary to factor in many other considerations before purchasing stocks. I will be reviewing many of these considerations in the coming days and weeks.