WE’RE HOSTAGE TO THE FED AND THE STREET

WE are back to waking up every morning wondering what sort of world has been made overnight for us in New York and down Wall St way, at the bottom end of Manhattan in particular.

That is, so far as the investment environment is concerned: most immediately and obviously what’s likely to happen when our stock market opens at 10am, but also to the value of the Aussie dollar and interest rates.

We first “woke up” to that chilling reality back in October 1987, when Wall St dropped more than 20 per cent in a single day, and a similar one-day fall was dead, deadlocked into our downunder market before a single share had traded.

We saw it again with the Global Financial Crisis in September 2008, although more in an extended traincrash over days and weeks after Lehman Brothers went down rather than a one-day plunge over the cliff.

And we saw the same downunder day-followsnight inevitability play out yesterday: overnight Friday the Dow plunged over 400 points; yesterday our market followed with a 69 point drop.

Clearly, comfortingly, the scale of yesterday’s drop was nothing like the previous two episodes. And there’s nothing to yet suggest that this might have been one of those “small shocks” that precede and indeed predict “the big one”.

Indeed, 400-point Wall St drops have become dime-a-dozen events and not just because the Dow is up around (what is a stillnear all-time record) 26,000 points, but because we live in more volatile times. Share prices can plunge, they can soar – and they do, more than they used to.

Indeed, we’ve just lived through a few months when the Dow went down a thumping 4000 points and then promptly came all of that back.

To emphasis: barely a month going down, barely a month to come back.

The proximate cause of the plunge was a combination of some uncertainties over the dazzling and seemingly never-ending rises in the share prices of the great US and global tech stocks – Amazon, Google, Apple, Microsoft and to a lesser extent Facebook – and the seemingly relentless rise in the US official interest rate.

HIGHER policy interest rates are usually – and indeed, should be, at least initially – bad for share prices and especially the share prices of “glamour”, already highly-priced, stocks like the above cohort.

The immediate cause of the bounceback was therefore the clear indications from the Fed – the US Federal Reserve, their version of our Reserve Bank – that it would ease off doing anything with interest rates that would be too unwelcome on “the Street”.

Late last week, the Fed went even further. It essentially promised Wall St it would abandon any further rate rises.

It even hinted that it would top up the proverbial punchbowl with 100-proof hooch if the party showed any signs of flagging.

Initially, Wall St went whoopee: on the first day of post-promise trading the Dow went up over 200 points.

But then, on the second day, it started to look the “Fed gift horse” more closely in the mouth.

Bluntly: what do these guys know but are aren’t telling us which has got them worried big-time?

The answer is, actually, nothing. Other that is, than the uncertainties about US and global economies which are out there for all to see.

My take is that the US economy – the biggest and still the most important in the world – remains in pretty good shape.

So, in terms of those “waking ups” to come, the biggest influence in my view is going to be the Fed’s promise to not simply “do what it takes” to keep Wall St happy, but to over and maybe even pre-emptively deliver.

That almost certainly means greater and more exaggerated volatility. Wall St will swing from confidence in the so-called “Fed put” – with down-days or even more extended drops like we saw in December demanding more “Fed hooch” – to panics over bad stats on the economy or “events”.

In sum, our market is now even more clearly hostage to what happens on Wall St, which in turn is hostage to what the Fed does and perceptions of what it might do (and why), with the Fed in turn hostage to what happens on Wall St in a bizarre feedback loop.