The stock market has been all over the place in recent weeks as it struggled with sizing up the Fed’s next move. Sentiment appears positive ahead of the open, with plenty of green arrows from overnight market action in Asia and Europe. But as we have seen repeatedly in recent days, the mood could shift very easily during the day.
On the data front, the New York Fed’s Empire State manufacturing survey came in better than expected. We have the homebuilder sentiment index coming out a little later today, with the index expected to be tick up from the prior-month’s level.
We have other housing-related data on tap later this week, with housing starts and permits numbers coming out on Tuesday expected to show continued momentum in this key sector of the economy. Also coming out this week is inflation, leading indicators, and the Philly Fed regional manufacturing survey.
But the most important event this week is the conclusion of the Fed’s two-day FOMC meeting on Wednesday, economic forecasts from the committee, and the Bernanke press conference. The hope is that investors will get a clearer sense of the Fed’s thinking on the ‘taper’ question as a result of developments on Wednesday. The markets understand that tapering didn’t mean the end to the QE program and that the eventual rise Fed Funds rate was a long way off.
But markets tend to look ahead and start reflecting those future end-points. The recent spike in long-term interest rates is a reflection of the bond market pricing those future Fed actions. Bernanke’s assurances next week will be useful, but the Fed doesn’t have a lot of influence over the longer end of the yield curve beyond the QE program.
The reality is that the Fed will start pulling back on the QE program if it feels that the economy was on a strong and sustainable footing. Higher interest rates are no doubt problematic for stocks, but they could potentially be offset by a growing economy and the associated improved earnings.
As such, a change in Fed policy would be a very reassuring signal about the health of the economy. And a stronger economy is far more beneficial to the stock market than more monetary stimulus.