"Free markets to Fed markets: How modern monetary policy impacts equity markets" Putnins, Talis J. Flashcards
What is the main idea?
The paper by Talis examines the role of FED played by them intervening in the markets through asset purchasing programs.
Why were many market observers concluding that “Wall Street [is] disconnected from reality” and “the stock market is ignoring the economy”?
Crisis began –> S&P fell
In March 2020 started increasing, increased 31% in 2 months and reached the pre-pandemic level while the economy was still suffering.
Market has been fearing that stock markets became disconnected from the economy during the pandemic.
How did stock return movements impact the Fed’s balance sheet actions?
Falling stock prices –> Fed expands its BS (purchases bond ETFs)
Rising stock prices –> Fed contacts its BS
The Fed responds more strongly to negative stock market returns than it does to positive market returns.
How did the Fed’s BS actions impact stock returns?
Fed expands its BS –> Stock returns increase
Fed contracts its BS –> Stock returns decrease
Stock market is more sensitive to the Fed’s balance sheet contractions than it is to balance sheet expansions.
How fast were the reactions of the Fed’s and the stock market to changes in the other?
Stock market reaction to Fed’s intervention was strongest in the next 2–3 weeks, rather than instantly. (Faster reaction)
Fed reacted to stock market changes with a 2–5 week delay (takes time for policymakers to formulate and then implement a response). The response takes 5 to 10 weeks to fully materialize.
Which Fed action do stock returns rather react to?
Stock market largely responds to realized BS changes, not to announcements about BS expansion/contraction, which would imply an earlier reaction.
Which sectors are more sensitive to Fed’s interventions?
Cyclical sectors such as consumer durables and small stocks are far more sensitive to the Fed’s interventions than less cyclical sectors such as utilities and large stocks.
What are the 2 main channels for how the Fed’s intervention in fixed income markets impacts stock markets?
- Long-term bond yields – they fall when Fed buys fixed income securities –> equity discount rates fall –> stock price increases.
- Fed’s actions impact expected future macroeconomic conditions and thereby expected future corporate earnings.
Additionally,
● Scope of the Asset Purchasing Programme during COVID:
If Fed only participated in the fixed income markets, stock impact minimal due to limited spillover effects;
However, the FED’s willing to do “Whatever it takes’’ to avoid stock market collapse has signalled it could directly intervene (buy equities through ETFs) –> This signal sent by FED may have provided an additional positive shock to equities.
How much of the stock market’s rebound was Fed responsible for?
The Fed’s aggressive balance sheet expansion during COVID-19 explains at least one-third of the stock market’s rebound following its crash in March 2020.
Therefore, central bank intervention in markets explains some of the apparent disconnect between stock markets and the economy due to the countercyclical nature of central bank intervention.
What is one of the major policy questions facing CBs looking forward?
Whether/when/how to unwind the positions accumulated during the pandemic.
What is the overall impact of Fed’s action?
FED’s actions had considerable positive impact on the US stock market, explaining around 1⁄3 or 1⁄2 of rebound.
