Friday, January 16, 2015

Is the Fed's Liquidity Pump Responsible for Intraday Price Action?

Yesterday we highlighted that our Weak Stock Market Close Indicator indicator had surged to the highest level since 2012 and today a client made the good point that our Weak Stock Market Close indicator seemed to give more false signals when the Fed was engaging in QE. That is of course a correct observation. In the first chart below we show our Weak Close Indicator chart overlaid with grey shaded regions during periods of QE. We got a false sell signal early in QE2 and then an even larger false sell signal in 2013 during QE3.
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The reader will further note that the Weak Close Indicator shoots up during periods without QE such as mid-2010, late 2011 and now. To more clearly demonstrate that last point we've overlaid the Weak Close Indicator on the three month change in Federal Reserve Assets (chart below) such that we’re comparing the flow of asset purchases to weak market closes. Weak market closes seem to increase when the Fed takes its foot off the accelerator. It’s not terribly surprising then to see more weak closes of late, just like when QE ended in 2010 and 2011. 

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As our regular readers have probably seen in our other blog posts, we have also observed a relationship between the deceleration of Fed asset purchases during the taper and things such as the compression in bond yields, counter cyclical stock outperformance, weakness in commodities, and narrowing stock market breath.  Fed liquidity trends have had all sorts of effects on asset prices and the ending of QE seems to go a long way in explaining recent market moves. Charts below.

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