I have read so many items over the past few days trying to explain why a dovish Fed caused risk assets to sell off. The consensus from those views seems to be that:
- The Fed lowered its forecast for growth
- The consensus is surprised by the lower forecast
- So risk assets sell off
This line of logic only works if
- The consensus does not have strong conviction of its own forecast
- The consensus is not aware of the weakening of the data
- The consensus growth forecast is significantly stronger than the Fed’s
None of these assumptions apply – if anything, the opposite is true. It seems many commentators are convinced that the Fed is increasingly behind the curve, which implies that they are more convinced of their own views and that the Fed is wrong. And consensus forecasts, as well as market pricing has for very many quarters now priced in a weaker growth projection that the median SEP dots.
The much simpler explanation is that the market simply rallied on the rumor and sold off on the news, as it has tended to do for years now. Take a look at the SPX reaction following the days QE programs were announced or expanded since the end of the recession:
Obviously, the sample size is small, but it’s large enough for us to note that the 1.6% drop on Friday was not at all out of the ordinary. In fact, the usual reaction is that the S&P trades off over the following 2-3 weeks before rallying.