This is the Golden Age of Fed Watching. And we’ve done our fair share. On a day when we have speeches from 5 Fed presidents and 1 governor, what more is there to say that hasn’t already been said?
Faith in the Fed is high, and capital market FUD (Fear, Uncertainty, and Doubt) seems to be low. We last wrote about FUD in July of 2009, as markets were worrying about the unwinding of Fed emergency support facilities. As it turned out, asset purchases by Bernanke et al. proved to be a very effective tool to calm investors. In retrospect, it should have been reassuring that investors were worried about anything at all. Fast forward to today, and as the reality of another round of QE has become baked in the cake, what we are seeing is:
1. High correlations
2. Low volatility
3. Falling volume
The following chart shows the 2 month rolling correlation between the S&P 500 index and the US dollar index (-0.92), as well as between the S&P and the gold spot price (0.92). If you were bored enough to take the absolute value of each of these two correlations and sum them, you would see that this metric would be at the highest level of at least the last 3 years (but who would be that wonkish?).
The next chart shows two market volatility indices, the MOVE and the VIX. The VIX index measures expected future price volatility in the equity market, while the MOVE index is the corresponding volatility measure for the fixed income market. In short, expectations for future volatility are very low when compared to recent years.
Lastly, volume has been on the decline. Since the equity market bottom in March of 2009, the 60 day moving average of volume on the NYSE is down roughly 30%, even more from the levels of 2006 and 2007.
If we were to create a FUD index for the capital markets, it would seem to be at very low levels. It’s worrisome that seemingly few investors are worried, but that could change at any time.
Case in point: we weren’t even able to finish this piece before PIMCO, Blackrock, and the New York Fed announced plans to go after Bank of America over mortgage losses, and all of the measures above reversed course: the equity market sold off significantly, bonds rallied, gold dropped nearly $40, the VIX spiked, and equity market volume took off.
Perhaps this is a fragile complacency.