Legg Mason Perspectives
|Market CommentaryWe all may have views on what the governmentshould do, but as investors we are better served byocusing on what they will or are likely to do, andhow those actions may aect the capital markets.This is no easy task, as the markets are continuous-ly revising asset prices as new inormation arrivesor probabilities change.Just now, as the Fed embarks on a second roundo quantitative easing, there’s a lot o noise anduncertainty about whether the announced $600 bil-lion is enough, how big the asset purchases mightultimately become, whether the program is alreadydiscounted in prices, whether it will engender toomuch ination, and so on. Lots o questions.The answer is, nobody knows. This is an experi-ment being perormed on a tightly coupled, highlyinterdependent, complex adaptive system, “adelicate machine the working o which we do notunderstand.” I we did understand it, we would notnow be in the present predicament. So, as withmost things involving markets, a good deal o hu-mility is called or, but is not much in evidence.I think it’s helpul to recall what is prompting QE2.The Fed employs monetary policy in pursuit o adual mandate: ull employment and price stability,neither o which is currently being achieved. Thenormal tool or this, the ederal unds rate
, can’tgo lower, so they are driven to try other methods,in this case asset purchases. The important pointis that they will continue to purchase assets, injectliquidity into the system, and grow their balancesheet until they are convinced their objectives areon the way to being met. QE2 will last as long andbe as big as necessary to do that.The transmission mechanism, the way this is sup-posed to work, is through higher asset prices, par-ticularly stock prices. The Fed wants the stock mar-ket to go up, and they will do what’s necessary toget it to whatever level it takes or the wealth eecto higher stock prices to stimulate growth, hiring,and ination expectations o around 2%. WhenChairman Bernanke signaled this in late August, ittook the market a ew days to digest it, then stocksbegan a rally that took us up around 10% goinginto the election and the FOMC
meeting. Ater theelection and the President’s signaling a willing-ness to extend the Bush tax cuts or everyone, andonce the Fed made clear what the QE2 policy was,we’ve had another spurt higher. In an editorial inthe Washington Post, Chairman Bernanke wroteexplicitly o the desire to get asset prices, bothstocks and bonds, higher. There is a lot more to goin the next twelve months, in my opinion, in stocksi not in bonds. That’s 12 months, not 12 days or12 weeks. I think the market can be up another15% in the next year, and perhaps more, depend-ing on how the economy does.
The federal funds rate is the rate charged by one depository institution on an overnight sale of immediately available funds (balances at theFederal Reserve) to another depository institution; the rate may vary from depository institution to depository institution and from day to day.
The FOMC is a policy-making body of the Federal Reserve System responsible for the formulation of a policy designed to promote economicgrowth, full employment, stable prices, and a sustainable pattern of international trade and payments.