Fed Taper

The current Federal Reserve Chairman Ben S. Bernanke and Kenneth N. Kuttner wrote the paper titled “What Explains the Stock Market’s Reaction to Federal Reserve Policy?” (http://www.federalreserve.gov/pubs/feds/2004/200416/200416pap.pdf)

Ben S Bernanke learnt that Federal Reserve policy surprises will have an effect in the stock market. If the surprises are on the positive, then equity prices will rise; and the opposite is true. The absence of Fed Taper cause equities to celebrate as equities as assets could remain high. Why? If US10yr bond, considered as theoretically risk free, goes for 2.6%, the S & P 500 yield would go happily at this low level (plus a bit risk premium).

Fed Taper

The August 2013 FOMC did not reduce US10B worth of bond purchase. This constitutes a positive surprise to the upside. Let us look beyond the chatter and just narrowly look at this paper Ben S Bernanke published and the decision. It leads to the only question, ‘Why would Ben S Bernanke engineer this surprise?’

Fed and unlikely bedfellow, US Treasury

The US treasury needs to sell those equities held up during the days of TARP. Treasury could not sell them with profit it prices of equity keeps coming down. One way is for the Ben S. B to generate a positive surprise to prices of equity. Treasury did sell some shares during the period. (http://www.treasury.gov/initiatives/financial-stability/reports/Pages/daily-tarp-reports.aspx)

The data as of 27 Sept 2013, Treasury accounted that it has recovered $423B of the $421B spent. (http://www.treasury.gov/initiatives/financial-stability/reports/Documents/Daily%20TARP%20Update%20-%2009.27.2013.pdf). That means, technically, the treasury is in the money.

The Billion dollar question is will they try to make another surprise on the upside? The balance of probabilities says it’s rather difficult. The market could be fooled once (read book by James Surowiecki, “The Wisdom of Crowds), and diffcult to fool progressively.

If the hypothesis is true, fed taper could be round the corner as the US treasury’s TARP program is also in-the-money.

28 Sept 2013

Disclaimer, believe at own risk. I am long USD. Fed Taper.