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Wednesday, June 10, 2020
The Effects of the Fed's Super-Loose Monetary Policy Are Being Felt
ANBOUND

The Federal Reserve began a two-day meeting. While no major policy announcements are expected, investors will scrutinize its remarks on the health of the economy. So far, the capital markets have reacted with optimism about the outlook for the U.S. economy. Now, the U.S. stock market has largely recovered to pre-pandemic levels, with the Nasdaq index hitting consecutive record closing highs, even briefly breaking the 10,000-point mark on June 9. As a result, many people are optimistic about a "V-shaped" recovery in the U.S. economy, believing that the most dangerous moment is over and expecting the boom in financial markets to bring confidence and support to the U.S. economy.

However, ANBOUND’s researchers are of the opinion that the continued rise of U.S. stock market is more of a sign that the Fed's monetary policy is having an impact. Although the recovery of the market has demonstrated the effect of the Fed's super-loose policy on financial markets, the massive increase in the money supply is also increasingly showing negative effects. As ANBOUND has pointed out before, this is actually the "effect of excess capital".

For the capital market, this effect alleviates the liquidity crisis in the short term and helps financial institutions obtain funds to cover paper losses caused by market fluctuations. Now, the stock market recovery suggests liquidity risk has eased and hot money is shifting from safe havens such as bonds to risky assets, which has pushed the stock market to continue to rise. The yield on the 10-year Treasury note is a paltry 0.67%. In contrast, a recent report from the Cleveland Fed pegged market inflation expectations for the next decade at 1.2%. This means that the Fed's policy rates will remain low for a long time. In that case, owning the safest bonds on the market right now may not be wise. Therefore, investors are buying shares not because they are optimistic about economic prospects, but because they have nowhere else to park their money.

Due to the difference between the capital market and the real economy, although the capital market has basically recovered, the increase of money supply has not yet played a role in the real economy, and it is more of a self-circulation in the capital market. The rapid recovery of U.S. stocks indicates that the separation between the financial market and the real economy has become increasingly serious. The effect of the Fed's monetary policy on the real economy has also been declining. In fact, as far as capital markets are concerned, there are still two uncertainties about the fundamentals of the U.S. economy that cannot be resolved by monetary action. On the one hand, the Covid-19 pandemic is still spreading, the number of cases is still increasing even though some cities have begun to reopen. Many institutions are concerned about the possibility of a second outbreak, and the current social unrest in the United States will affect the process of economic recovery in the U.S., leading many to believe that the U.S. economy will show a "W-shaped" recovery". On the other hand, U.S.-China relations have deteriorated during the pandemic. The U.S. has been increasing sanctions and financial restrictions on Chinese companies, with no sign of easing at present. The same is true of U.S.-China trade frictions. If such friction worsens in the future, the capital market is bound to be affected and impacted. Moreover, such friction will now extend even further into capital markets and the financial sector, which will be hit even harder.

The super-loose monetary policy of the United States has brought unprecedented dollar liquidity to the market. While the rally of the U.S. stock market remains attractive, the flight-to-safety of global money to U.S. markets is reversing as valuations return to high levels, the global liquidity crisis eases and the pandemic gradually unwinds. This has been reflected in the trend of the dollar exchange rate. The dollar index has been falling recently, to below 97 from a high in March. International capital began to flow outward from U.S. capital markets. This means that dollar liquidity from the Fed's policies is beginning to spread around the world, certainly affecting other major markets and driving up asset bubbles around the world, but to some extent restraining the excessive expansion of U.S. stocks.

Therefore, the core of the Fed's rescue policy is to protect the U.S. capital markets and the interests of Wall Street. The recovery in the U.S. stock market suggests that the Fed's rescue mission has been completed and that the effects of super-loose monetary policy have spilled over and even fed back into the real economy. However, the employment downturn, pandemic, economic uncertainty, and the deflation all determine that the Fed's current policy is in a difficult situation. The Fed will adhere to the "unlimited" quantitative easing policy and is expected to keep the federal funds rate unchanged in its target range of 0% to 0.25% to keep the market running. The consequences of such easing will also be increasingly severe, which means that market flexibility is fading, and so is the potential for economic growth.

Final analysis conclusion:

The continued rally in U.S. stocks reflects the effectiveness of the Federal Reserve's bailout policy, keeping Wall Street's interests intact. Yet, the resulting excess liquidity exacerbates the global liquidity glut, further increasing the risks to capital markets and the real economy.

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