Santa Bernanke Delivers Early Christmas

‘Twas the night before the Fed meeting, when all through the floor, not one creature was  doubting, the central bank would do more. The investors were nestled all snug in their beds, while visions of money printing danced in their heads.

A “Santa Claus Rally” is known as a rise in stock prices during December, typically seen over the final week of trading before the new year. However, Christmas may have come early as Santa Ben Bernanke reached into his bag for another quantitative easing package.

On Wednesday, the S&P 500 logged its sixth consecutive day of gains. Over the past six trading sessions, the Dow Jones Industrial Average has closed higher five times, the longest rally for stocks since August. Many people gave credit to the hope of a fiscal cliff deal for the upturn, but Mr. Market was anticipating the Federal Open Market Committee would launch another round of QE. As expected, the central bank said it will purchase $45 billion in long-term Treasuries each month, in addition to its previously announced QE-to-infinity-and-beyond that buys $40 billion in mortgage-backed securities each month.

“The Committee remains concerned that, without sufficient policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook,” explained the Fed’s policy-setting panel in a statement. Stocks have now seen a run-up in five of the past six FOMC meetings.

The Federal Reserve also took the unprecedented step of pledging to keep interest rates at record lows until at least as long as the unemployment rate remains above 6.5 percent. The central bank implemented a zero interest rate policy in December 2008, and its own economic outlook does not project an unemployment rate under 6.5 percent until 2015.

Don’t expect that unemployment rate anytime soon…

Pimco’s Bill Gross, manager of the world’s largest bond fund, estimates the economy will need to add roughly 200,000 jobs per month for the next 4-5 years before the unemployment threshold is met. Gross also believes it is a “decent stretch” that the Fed will be able to control interest rates at such low levels in the coming years.

Although, even if unemployment falls to under 6.5 percent, Fed Chairman Ben Bernanke said other factors such as labor force participation, hours worked and inflation expectations will be considered before raising interest rates.

While the Fed placed a new bow on its latest QE package, Mr. Market showed more excitement during the anticipation phase. The S&P 500 hit as high as 1,438 on Wednesday, but barely closed in the green at 1,428. Meanwhile, the Dow reached a high of 13,329 on the day, but finished with a loss at 13,245. Even Treasuries declined after the Federal Reserve announcement, with thirty-year yields hitting a one-month high.

The Federal Reserve and European Central Bank continue to apply additional monetary easing at more frequent intervals, but the effects are waning with each package. The law of diminishing returns at its finest? Even Santa loses his effect after so many visits.

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