For the third time in the span of about twenty years, the Fed is in denial over an asset bubble its policies have helped foster. Bubble conditions are most obvious in the FANG segment of the stock market, but a value-based investor could point to many more areas of the market where values appear stretched. Yes, the Fed is now tightening policy, but the pace of tightening is about four years late and at a pace that the market finds laughable.
Here, the Wall Street Journal presents the facts of a failed Fed tightening.
Broad financial conditions are as accommodative now as they were in early 2015, the point of maximum Fed stimulus, according to a closely watched Goldman Sachs index, which measures the combined impact of movements in interest rates, stock prices and the value of the dollar.
Easy financial conditions create a risk the market could overheat and then snap back, sending yields soaring and choking off lending, said Torsten Slok, chief international economist at Deutsche Bank Securities. “The rubber band is stretching out here.”
In theory, financial conditions should serve as the conduit between the Fed’s monetary policy and the real economy. When the Fed lifts short-term rates, long-term rates should rise also and financial conditions should tighten.
The fact that the central bank and Wall Street are moving in opposite directions suggests limits to the Fed’s influence over the economy. If it persists, it could also prompt the Fed to shift its strategy. If your dance partner doesn’t follow, you might hold that person tighter.
“If we decide that we need to tighten financial conditions and we raise short-term interest rates and that doesn’t accomplish our objective, then we’re going to have to tighten short-term interest rates by more,” New York Fed President William Dudley told The Wall Street Journal last year.
Read more here.