Fed to maintain stimulus as markets at risk of sharp fall

The Federal Reserve is set to continue its monetary stimulus. Bloomberg reports the outcome of the Fed's monetary policy meeting on Wednesday:

Federal Reserve Chairman Ben S. Bernanke said further gains in the U.S. labor market are needed for the central bank to consider reducing its record monetary easing.

“Obviously, there has been improvement,” he said at a news conference in Washington today after the Fed decided to leave the pace of asset purchases unchanged at $85 billion a month. “One thing we would need is to make sure that this is not a temporary improvement.”

The Fed's forecast for the unemployment rate at the end of the year has been lowered to a range of 7.3 percent to 7.5 percent from a previous forecast of 7.4 percent to 7.7 percent. The forecast for economic growth was revised to 2.3 percent to 2.8 percent this year compared with the earlier forecast of 2.3 percent to 3 percent.

While the Fed hopes that the extension of monetary stimulus would help the economy expand, Cullen Roche at Pragmatic Capitalism sees the possibility of it leading to excess. Indeed, Morgan Stanley's Gerard Minack thinks that emerging market debt and developed market high-yield corporate debt are two areas that could see “more dangerous mis-pricing of risk emerge in coming quarters because monetary policy is likely to remain loose, liquidity plentiful, and investors will continue to hunt for yield”.

Meanwhile, Doug Short at Advisor Perspectives notes that investors are increasingly bullish on US equities. Quoting another investor, he writes that “bull markets go for as long as they go and for whatever reason” but it is the “terminal valuation that determines the degree of damage done in the subsequent bear market”. And he shows that from current valuation, the market has in the past fallen by over 30 percent.