Behind the Money

Fed Chief Still Moves Markets, But Not the Way He Planned

Many investors and economists have been questioning whether Federal Reserve Chairman Ben Bernanke can still influence the markets with his monetary policy. The market's recent performance clearly shows he can—but not in the way he intended.

During the just-ended third quarter, the top performer among U.S. asset classes was 30-year bond futures, which jumped more than 17 percent. Futures linked to the 10-year note were not too far behind, climbing 7 percent.

Meanwhile, the S&P 500, the broad measure of the US stock market, lost 17 percent.

Those results can be directly attributed to the much-anticipated Sept. 21 announcement by the Fed to embark on “Operation Twist,” which is aimed at keeping longer-term interest rates low and encouraging investors to take on more risk—like buying stocks. The problem is that investors keep piling into bonds, not stocks.

“Following Uncle Ben worked again,” said MercBloc’s Daniel Dicker, echoing the old Wall Street maxim ‘Don’t Fight the Fed.’  “Bonds keep going higher because everyone believes they can’t keep rising. Yet, they do, blowing out those betting on a decline.”

A look across the investment spectrum has Ben Bernanke’s not-so invisible hand all over it. Gold was among the top performers on concern that this newest form of monetary stimulus, along with the two previous rounds of quantitative easing, would spark inflation.

But Ben’s impact was felt very much on the downside too.

Copper was the very worst mover (down 28 percent) over the last three months after the Fed said in its September statement that “there are significant downside risks to the economic outlook.”

“One of the (many) problems with QE and derivations of that (i.e., Operation Twist) is that investors have to sell something to buy something,” said Joseph Lavorgna, chief U.S. economist at Deutsche Bank. “In the case of ‘Twist’, if the Fed is going to artificially lower rates, investors will clamor into bonds, and in the process, they sell the risky assets that arguably the Fed wants them to buy.”

That’s the rub here, traders said. Bernanke is still moving interest rates and other markets, but the desired effect by the Fed Chairman—to increase lending and riskier investment—is not happening.

Among the major sectors in the S&P 500, banks lost nearly a quarter of their value over the last three months as the Fed’s shift to buying longer-term securities flattened the so-called yield curve.

The move hurts the ability of institutions to make money by borrowing at low short-term rates and lending out over the long-term at higher rates. Banks added to these losses on the first day of the new quarter Monday.

“The question is effectiveness,” said Fisher, the Dallas Fed president who opposes another round of quantitative easing. “Who’s taking the liquidity -- which is abundant and cheap – that we have provided and putting it to work?”

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