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It's Not About Syria

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Wednesday, September 4, 2013

Syria is getting all the blame for the market’s current nervousness, with Tuesday’s House leadership’s support for strikes cited as the reason for deflating the day’s earlier market gains. The prospect of another conflict in the Middle East is no doubt destabilizing, but I doubt if Syria is the primary source of current market nervousness.
There is always more than force at play and Syria is likely playing some role on the margin, but the primary unsettling factor for the market is the Fed. Tuesday’s pullback was not so much a reaction to the show of support from House GOP leaders, but rather a reaction to greater likelihood of Taper announcement in this month’s FOMC meeting following the strong ISM numbers. We don’t have much economic data on today’s docket, other than the trade deficit in the morning and the Beige Book later this afternoon, but Thursday and Friday bring important labor market data that is very important for Fed watchers.
One would think that stock market investors would have gone past the Taper issue by now. But many appear still to be hoping for the Fed to hold off on announcing any changes on September 18th. They are pinning their hopes on the Fed continuing with the QE program in full force till the budget/debt ceiling fight in Washington is amicably settled. I don’t think it matters much whether the Taper announcement comes this month or a couple of months down the road, as it is practically a given at this stage that the Fed is preparing to get out of the QE business. My sense is that Bernanke wants to move past the Taper issue on his watch, leaving his successor all the flexibility he (or she) will need to proceed from January onwards.

The issue isn't so much the amount of 'Taper' either, it's about what the move tells us about the central bank’s the long-term monetary stance. Bernanke and others on the FOMC have been going to great lengths to emphasize that the overall stance of monetary policy will remain extraordinarily accommodative even after Taper gets underway. All the Fed efforts at forward guidance and unemployment rate targets are geared towards emphasizing this aspect. But the bond market sees the Taper not just as a mere reduction in monthly bond purchases, but as the start of a long run monetary policy normalization process.

Taper and the expected changes to Fed policy are not cataclysmic events, but they do represent a material shift in the super accommodative macro framework of the last few years that was very beneficial to the stock market. Everything else equal, the stock market will find a new equilibrium level in response to this Fed change. In the absence of a material improvement in corporate fundamentals, the market’s new equilibrium level is likely a lot lower than current levels. Brace yourself for a bumpy ride in the coming days.
Sheraz Mian
Director of Research


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