The paradox of no market response

There seems to be genuine uncertainty about what the Fed will do, or not do, this September.

At a superficial glance, the good news scenario is if the Fed’s decision doesn’t matter much for the markets.  Woe unto you if your economy is so fragile that a quarter point or so in the short rate, mixed in with some cheap talk, were to matter so much.

So if at first prices were to stay steady, following any Fed decision, then equities should jump in price.  That is the “no news is good news” theory, so to speak.  It’s a better state of the world if it is common knowledge that the Fed’s actions don’t matter so much in a particular setting.

What if prices jump right away, following a Fed decision?  The market might then see that price jumps rely on the Fed making good decisions, whatever those might be.  The risk premium might then go up.  It is even possible that prices should on net fall in response to that, but in any case it seems that some further price adjustment is in order, perhaps in the downward direction.  (That ought to come rapidly.)

Most generally, it seems the initial price move, in response to the Fed’s choice, cannot itself be correct, but that first price move must itself induce further price movements.  The price move in response to the Fed’s decision is the economy telling us how much it is relying on the Fed, which right now we do not know.

Maybe the Fed would like to know this too.


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