Many investors and strategists have been arguing that the Fed lost its window of opportunity to hike rates when the good professors panicked during the stock market correction in August. The decision backfired as the Fed told the public that global financial conditions were bad enough not to hike in September, but not so bad that the Fed wouldn’t hike sometime in 2015.
The market took the Fed’s panic as a sign of weakness. If the Fed didn’t hike in September what would encourage them to hike later in the year? Investors pushed interest rates down sharply over ensuing weeks and the probability of an interest rate hike in 2015 plummeted.
Yellen & Co., tried to push back against the notion that a rate hike is off the table in 2015 by delivering a hawkish policy statement yesterday.
Short-term interest rates moved up sharply on the news and the probability of an interest rate hike at the December meeting soared. My chart below shows the reaction in stocks. The market initially gave up all of its gains for the day (no more free money), but then it soared (that’s a different reaction).
It would seem that Yellen & Co., have convinced the bond market that the Fed hasn’t lost its window of opportunity to hike rates in 2015, but stock market investors don’t seem to care. They are apparently focused on another window that many have ignored.
What window might that be? The window for the Fed to contain the bubble conditions in the stock market.
One interpretation of yesterday’s powerful stock market rally might be that investors now think the Fed is so far behind the curve that even if rates are increased in December it will be too little too late to prevent already inflated stock valuations from moving further into the stratosphere.
I certainly hope that’s not the case because the last thing retired and soon-to-be retired investors need is another stock market crash to go with their seven year interest rate famine, but it is a risk worth considering.
Jeremy Jones, CFA
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