Evidence that monetary policy was important in late '08.

As a general rule, during late 2008 increases in stock prices were correlated with increases in nominal yields, inflation expectations, and expected future Fed funds rates. This isn't surprising. If the correlation  between expected future fed funds rates and other asset prices breaks down however, it should give some kind of an idea of impact of monetary policy.

There are two very notable days which I believe show the strength of monetary policy during the period. The first (October 28) was positive and the second (December 1) was negative.

1) October 28, 2008. The S&P rallied 10.79%, the 30 year treasury yields rose 7 basis points, 10 year Treasury yields rose 4 basis points, AAA bond yields rose 10 basis points and BAA rated bond yields rose 9 basis points, and the 10 Year TIPs spread increased from .77 to .83. Meanwhile the expected FF rate in December fell from .860 to .825 and the three month treasury yield fell from 0.84 to 0.77. If this were related to some non-monetary shock, FF futures and treasury yields should have risen, not fallen.

I expected that there may have been some bailout or financial news that pushed up markets, but when I looked there was nothing of the sort. News that day noted that... "Stock analysts struggled to make sense of the gains"  but also acknowledged that the Fed may be partly behind the rally.

2) December 1, 2008. S&P down 8.9%, 30 year yield fell 23 basis points, 10 year yield fell 22 basis points, AAA yields fell 25 basis points, BAA yields fell 19 basis points and the TIPS spread rose by 1 basis point. Meanwhile, the December expected FF rate rose from 0.417-0.433, 3 month treasury yield rose 6 basis points and the dollar rose by 0.23%.

Again there was no clear news event that day that would cause such a collapse.

Obviously if you are only looking at days in which monetary policy and markets moved it opposite directions it will, by definition, look like monetary policy matters a lot... but the magnitudes are what are impressive. Those days represent the second biggest gain and second biggest loss in equity prices during the entire crisis!

And what of the biggest gain and biggest loss days? They also seem to be correlated with changes in the perceived stance of monetary policy.

October 13th was the biggest rally of the period (and the fifth biggest rally in the DOW EVER) and, "The surge came as governments and central banks around the world mounted an aggressive, coordinated campaign to unlock the global flow of credit, an effort that investors said they had been waiting for."

And the biggest losing day of the period? Two days later on October 15th. Guess what sent the market tumbling.

"Selling picked up momentum in the afternoon as the Federal Reserve’s chairman, Ben S. Bernanke, cautioned Americans that the bailout would not swiftly lift the economy and that continued weakness was certain."

The selloff seems like exactly the type of reaction one might expect if markets thought the Fed would do what was necessary to prevent NGDP from falling the 13th, only to realize it was hopelessly focused on the financial crisis (and not aggregate demand) two days later. And why would a Fed Chairman ever say continued weakness was certain? If that was the case shouldn't they ease policy?

(Data for the S&P was acquired form Google Finance, Fed Fund Futures data was acquired from the Cleveland Fed, and all other data was downloaded from FRED)