MBS RECAP: What's up with the Weird Market Reaction to FOMC?

Today's FOMC Announcement resulted in one of the strangest market reactions in recent memory.  Explanations for the various movements abound, and most of them unfortunately contradict each other. 

For instance, one of the popular conclusions is that the Fed's mention of international issues means they won't be able to remove accommodation as quickly because the international economy is in rough shape, thus the bond market rally.  Up to that point in the logic, things are fine, but then consider the massive stock market sell-off and it falls apart.  More Fed accommodation should be positive for stocks.  So this theory falls apart there.

The next theory argued that the statement was hawkish (meaning it hearkened less accommodation than conditions might suggest).  This one would explain the stock market weakness, but it's harder to get to the bond market strength.  Harder... but still sort of possible.  It could be done by leaning heavily on the currency implications of a stronger dollar hurting stocks and creating demand for bonds (buy bonds in today's dollars and earn back an appreciating currency over time).  The big problem here is that there was too much disconnection between stocks, bonds, and currency trading levels.

A variant of that argument begins to hone in on what I think is the most plausible explanation.  It too argues that the statement was hawkish due to the Fed seemingly not backing down from the rate hike time table quickly enough.  That part is wide open to interpretation, but the conclusion would hold that stocks would take a big hit.  From there, we could make the leap to bond markets picking up some "asset allocation" flows (i.e. money managers selling stocks to buy bonds).

Whether it was motivated by stocks or not, the critical ingredients in this afternoon's strength were simply a few big trades that forced other traders onto the same boat.  This wouldn't normally be quite as possible after a Fed Announcement, but keep in mind the level of participation is low this week and expectations for a boring FOMC didn't help.  Volume was just a bit better than HALF of what it was back when markets were trading important issues like the European bond-buying court ruling on January 14th.  Even compared to the average over the past 10 sessions, today was about 60%.   Ultimately, it's that kind of light participation that's necessary to grease the skids for the kind of weirdly strong movement we saw this afternoon.