Note: the Fed lquidity update is below this intial post from a few weeks ago.
As all are likely aware, the Federal Reserve has been normalizing the short term Fed Funds rate for over a year now, by raising the target rate from its emergency 1% level (the post 9-11 rate reduction exercise) to its current rate of 3.00%, likely 3.25% by the end of today.
The “measured” Fed funds target rate hikes do not necessarily smother liquidity injections into the financial system. Where the Fed can affect liquidity, is via the level overnight lending rate, known as the effective (actual) rate, relative to the target rate (the rate that is going from 3.00% to 3.25% today). The daily Fed effective rates can be found at this link:
It is generally the Fed overnight loan trading desk’s job to keep the effective rate charged member banks close the target rate. When the effective rate is higher than the target rate, there appears to be a negative impact on the behavior of stock prices, i.e. stock prices have a tough time making upside progress. Conversely, when the Fed overnight effective rate is less than the target rate, the path of least resistance for stock prices is usually to the upside.
This first chart measures the percentage deviation of the Fed effective rate (actual rate charged for short term loans) from the Fed funds target rate. The daily data is then smoothed with a ten day simple moving average. Note when the blue curve is below the zero line, denoting the effective rate has been higher than the target rate, stock prices move in a sideways pattern at best, and decline at worst.
However, when the overnight effective rate is less than the target rate, denoted by the blue curve spiking above zero or remaining above zero, stock prices tend to move higher. Note since the first of 2005, the blue curve has rarely exceeded the zero line, resulting in range bound stock prices. The same relationship too place in 2004, until the Fed overnight desk began lending funds at rates below the target rate.
Note the spikes above the zero line circled in green coincide with “easier money” at the first of each calendar year.
The New York Federal Reserve publishes daily, its temporary Open Market operations, and can be found at this link:
Member banks submit proposals to the New York Fed office for borrowing a specified sum of money at a specified interest rate. In turn, the Fed office accepts or rejects the member bank’s proposal submittals. The next chart measures the percentage of submitted proposals (in billions of dollars) that are accepted by the New York Federal Reserve. The daily percentage of accepted proposals is smoothed with a simple 10 day moving average (blue curve). Note when the blue curve is below 25% for an extended period of time, stock prices have a difficult time appreciating in price. The indicator has been below the 25% line for the past ten weeks, resulting in a range bound stock market, confirming the effective rate – target rate indicator.
In summary, the Federal Reserve does appear to have an influence upon stock prices. Periodic and robust infusions of liquidity into the financial system, seems to provide the stock market the “kick” it needs to move higher. Since both of these Fed liquidity infusion measures have been in negative territory for two to three months, and with the impact of oil prices on the economy, hopefully the Fed will loosen up on the liquidity reins allowing stock prices the opportunity to move out of their recent range.