Financial Markets Rattle the Fed
Historically, the semi-annual testimony to Congress on monetary policy by former Fed Chairmen has consisted of many platitudes. Consequently, there was usually very little guidance provided as to the future path of interest rates. Last week’s testimony by Fed Chair Yellen constituted, therefore, a departure from normal practice: she indicated a preference for higher interest rates sooner and more gradually vis-à-vis later and more rapidly. This signalled a departure from her earlier line of approach where she favoured a temporary overshooting of the Fed’s 2% inflation target in return for a more rapid return to potential GDP growth. Why the change of heart? The Fed Chair, along with other members of the Federal …show more content…
The old saying of “Don’t fight the Fed” could seemingly be looming large. The prospective path of Fed policy, while not totally conducive for bull markets, does not imply that US equity returns will be totally disappointing. While Fed Chair Yellen has indicated that she favours a higher policy rate in 2015, the trajectory of subsequent increases is likely to be very shallow. This is far more important for financial markets, because the behaviour inflationary expectations could play a significant role shaping US equity valuations and ultimately …show more content…
Signs of rising inflationary expectations are probably needed to produce significant P/E multiple compression. A repeat of the brutal events of the 1970s is, however, unlikely, because the Fed is in no mood to fall behind the curve. This suggests that the risks to equities in the intermediate term will, therefore, rise once monetary policy is forced to be adjusted sufficiently to prevent inflationary expectations from becoming unhinged. In the near-term, US equities could simply oscillate around current P/E multiple levels, the degree of which will be determined by the future progression of corporate
Historically, the semi-annual testimony to Congress on monetary policy by former Fed Chairmen has consisted of many platitudes. Consequently, there was usually very little guidance provided as to the future path of interest rates. Last week’s testimony by Fed Chair Yellen constituted, therefore, a departure from normal practice: she indicated a preference for higher interest rates sooner and more gradually vis-à-vis later and more rapidly. This signalled a departure from her earlier line of approach where she favoured a temporary overshooting of the Fed’s 2% inflation target in return for a more rapid return to potential GDP growth. Why the change of heart? The Fed Chair, along with other members of the Federal …show more content…
The old saying of “Don’t fight the Fed” could seemingly be looming large. The prospective path of Fed policy, while not totally conducive for bull markets, does not imply that US equity returns will be totally disappointing. While Fed Chair Yellen has indicated that she favours a higher policy rate in 2015, the trajectory of subsequent increases is likely to be very shallow. This is far more important for financial markets, because the behaviour inflationary expectations could play a significant role shaping US equity valuations and ultimately …show more content…
Signs of rising inflationary expectations are probably needed to produce significant P/E multiple compression. A repeat of the brutal events of the 1970s is, however, unlikely, because the Fed is in no mood to fall behind the curve. This suggests that the risks to equities in the intermediate term will, therefore, rise once monetary policy is forced to be adjusted sufficiently to prevent inflationary expectations from becoming unhinged. In the near-term, US equities could simply oscillate around current P/E multiple levels, the degree of which will be determined by the future progression of corporate