Federal Reserve Chairman Ben Bernanke has acknowledged the importance of stock prices to the efficacy of quantitative easing.
In a speech given last month in Indianapolis, Bernanke said, " Lower interest rates also put upward pressure on the prices of assets, such as stocks and homes, providing further impetus to household and business spending."
Deutsche Bank macro strategist Alan Ruskin thinks that may be understating the case. In a note to clients, he writes, " In the end, there is little doubt that as bond yields have approached a lower bound, the Fed is heavily dependent on other channels to ease financial conditions, from credit spreads, to equities and a weak USD."
Ruskin calls the "equity channel" of "particular importance" to the Fed.
And with a lot of uncertainty weighing on markets due to the potential for a "fiscal hurricane" to materialize, Ruskin says the Fed's QE3 program could be "very exposed."
At the first iteration, it would be expected that any weakness in real economy data (probably signaled by additional weakness in equities) would with a lag in 2013 lead to an additional QE Fed response, over and above the balance sheet expansion that is widely expected to be decided at the December FOMC meeting.
What recent events have shown is that the Fed will be very exposed if there are any large domestic (fiscal), or external (particularly EUR economy related) shocks. It is still likely that the risk trade has a significant Fed buffer, that particularly at current equity levels, creates an asymmetric bias for higher prices. But the Fed is by no means ‘a fail safe’ under any scenario. In a fiscal hurricane, with a negative fiscal impulse greater than 2% of GDP, Fed QE will struggle to provide a meaningful counterweight.
Minutes from the October FOMC meeting were released yesterday, and the big topic of discussion was tying monetary policy to explicit targets for variables like unemployment. Click here for the full text >
More From Business Insider