Hopes for Fed action on Thursday keep stocks moving up despite warning from Moody's

09/11/2012 3:03 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

It’s not so much that the Federal Reserve trumps Moody’s as it is that close at hand outweighs far away.

Today U.S. stocks are up on speculation that the Federal Reserve will announce some kind of stimulus—maybe even a third round of quantitative easing—when the meeting of its Open Market Committee concludes on Thursday, September 13.

That hope has been enough to cancel any negative reaction to a statement from Moody’s Investors Service that it would cut its rating on U.S. government debt if post-election negotiations in Washington didn’t produce a deal that reduces the U.S. ratio of debt to GDP. Moody’s kept U.S. debt rated AAA even after Standard & Poor’s cut its rating to AA from AAA in 2011. In August, though, Moody’s put the U.S. rating on negative outlook, signaling that the U.S. credit rating was in danger of a downgrade. If negotiations fail, Moody’s said today, it expects that it would lower the U.S. rating to Aa1, a grade below AAA in the Moody’s system. (The U.S. national debt topped $16 billion in August, pushing the debt to GDP ratio above 100%.)

But that rating downgrade is, if it comes at all, way off in December or January. The possibility of Fed action is just days away.

And Wall Street is convinced that the Fed will do something that adds liquidity to the economy—and more importantly to the financial markets. In this view last week’s disappointing jobs number for August will push the Fed to act now since waiting until the next Fed meeting on October 24 is uncomfortably close to the presidential vote. Typical of what Wall Street is looking for is this prediction by UBS for a six-month program of quantitative easing of at least $500 billion focused on buying Treasuries and an extension of the Fed’s promise to keep rates at current extraordinarily low levels until 2015.

I think Wall Street is doing more hoping than analysis at this point—which, of course, doesn’t mean investors won’t get what they’re counting on. It’s important to remember that the Fed has access to “future” data that hasn’t yet been released so what the economy looks like so far in September is more important than what it looked like in August. I know Wall Street wants another bucket of liquidity thrown at the market in order to move stock prices higher, but this argument cuts two ways. The current very strong rally has moved stocks up to a level that might make the Fed reluctant to pour more cash into the rally out of reluctance to inflate another (smaller) bubble.

The more stocks rally on hope, the more it creates the possibility of significant disappointment if the Fed doesn’t deliver on Thursday.