Feb

8

The Monetary Base is composed of 2 items: currency and deposits in Fed banks. The two are an interesting combination. If you look at the spikes in Monetary Base, the first one (Y2K) is entirely due to currency. The second one (9/11) is entirely due to the Fed goosing the deposits. That points out that despite some opinions to the contrary, the Fed definitely has some control over the process. Which is to say that changes in Fed policy can have significant effect.

Deviation from the fit does not correlate well with bullish or bearish equities, just as high or low interest rates (unless excessively so) also do not correlate well. The equities markets can get used to a level of interest rates, but uncertainty or volatility of those rates can have a deleterious effect on the stock market. That is, it's not the level, but the volatility of the changes. Because there are not enough examples, however, the analysis must be considered anecdotal.

Regarding the Fed's policy, they were restrictive during the 1996-99 period. But the decision to be less restrictive after the combined Asian Contagion, Russian Bond default, and collapse of LTCM, really sent the stock market soaring.

I ask the rhetorical question that if the Fed should back off their restrictive policy, what will happen to the stock market? However, I believe it is unlikely that they would back off without a triggering event.


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