Market Commentary (updated: 08.09.11)

Comments on the FOMC statement

The market's initial reaction to the FOMC's 2:15 statement was negative – a decline that more than wiped out all of the day's earlier gains. More than a few market participants had evidently been looking for more from the FOMC, though exactly what is not clear, as few believed an announcement of big changes such as a QE3 was likely, and none was announced. The FOMC acknowledged that growth is slowing and that the risks are to the downside – an outlook that warrants keeping the Fed funds rate target at exceptionally low levels at least through mid-2013, in their view. This is in line with the market's view: Private forecasters have been marking down their GDP forecasts for the coming year, and the futures markets had already been pricing in exceptionally low interest rates for many months to come.

The FOMC also announced that would maintain its existing policy of reinvesting principal payments on its securities holdings, in effect promising to continue to provide liquidity to the markets. The market quickly moved back into positive territory and beyond, possibly because the FOMC statement, while not signaling any new initiatives, at least indicated that the Fed stood willing to take further steps, if conditions warrant. The mere hint of the possibility of a third round of quantitative easing or other Fed action seemed to be enough to rally equity markets, as well as bond markets on the longer end of the yield curve and imply a weaker dollar going forward. Yields on the 2- and 10-year Treasury notes touched all time lows.

Yet, even professional investors were taken aback by the 600-point rally in the Dow in the final hour of trading. Postulated causes of the extraordinary market move include mutual fund managers executing on their convictions that oversold markets had reached attractive valuation levels, formerly bearish investors covering short positions, and for better or for worse, renewed certainty that the Fed will keep rates at record lows for the next two years giving enough comfort for equity investors to participate again.

While each of these explanations is somewhat unsatisfying, the positive close to the market might be a market-calming event in itself: It was accompanied by a decline in the VIX index of expected future market volatility to 35, its lowest level since Monday's market opening, and down from the 45 level it passed earlier in the day — a level close to that usually reached at the trough of market sell-offs.

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