Forget data and rhetoric, Fed liquidity’s the only show in town

(Reuters) – For all the fevered speculation about when the Federal Reserve will begin scaling back its monetary stimulus, market volatility has been taking a leisurely nap, suggesting investors see no major shocks on the horizon to derail their bets.

Low market volatility is a sign markets expect no “taper” any time soon, or that they are steeled for a reduction in the pace of the Fed’s bond-buying if it comes.

The sun rises to the east of the U.S. Federal Reserve building in Washington, July 31, 2013. REUTERS/Jonathan Ernst

The sun rises to the east of the U.S. Federal Reserve building in Washington, July 31, 2013. REUTERS/Jonathan Ernst

The sting of the taper has been gradually sucked out of markets since the Fed’s surprise decision not to start withdrawing stimulus in September.

Since then, implied volatility in U.S. Treasuries, stocks and key dollar exchange rates has sunk close to its lowest in months, or in some cases years.

This might come as a surprise, given the noise surrounding the latest relatively upbeat U.S. employment and economic growth figures and the keenly awaited congressional testimony from Fed Chair-elect Janet Yellen last Thursday.

But the Fed’s $85 billion-a-month asset purchase program trumps everything, and as long as the liquidity taps are open, the economic data will only have a real impact on markets if it changes the Fed’s thinking.

“We’re not trying to follow the twists and turns of the very short-term investment cycle,” said Kevin Gardiner, head of global investment strategy at Barclays Wealth in London.

The same goes for data or Fed commentary, he said. Only if they “dramatically changed” the Fed’s policy outlook would he consider altering his strategy.

Market pricing and indicators suggest he’s not alone. Wall Street last week posted record highs on an almost daily basis, and the S&P 500 .SPX and Dow Jones Industrials .DJI have risen for six consecutive weeks.

This has been fuelled by a collapse in volatility from the unusually high levels around the U.S. debt ceiling and government shutdown crisis in early October. The VIX index .VIX of implied volatility for the S&P 500 fell to a three-month low on Thursday.

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