The Fed’s announcement of ‘planning’ to reduce its bond purchases –despite continuing high unemployment and an economy weakened by reduced federal spending- is puzzling. Surely, the laggard GNP growth while inflation is under control should allow –even spur- the Fed to continue its policy of bolstering the economy.
It could be that the policy mavens fear that this bull market is overheating and will result in a massive drop.
Whatever the Fed’s motivation, this announcement of ‘planning’ signals that the Fed’s future actions will limit the prospects of this bull market.
That is a matter of simple arithmetic. When the Fed buys bonds, its action results in higher bond prices. The Fed is a massive buyer, and its demand like any other buyer’s desire will increase bond prices . . . and other asset prices increase in tandem.
This same mechanism works in reverse when the Fed reduces, or stops its bond purchases. With less demand, bond prices will fall . . . so will other asset prices decline in tandem.
So regardless of the Fed’s motivation, the announcement of ‘planning’ to limit its bond purchases means that some of the bull will be taken out of the current stock market.
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