Updated: 08-24-2015

The Fed and Market Panic
Updated: 21-Aug-15  05:28PM ET
Analyst: David Kelland

If you were vacationing in the Arctic Circle this week, you should know that it was a bad one for equity markets around the world. The S&P 500 finally broke out of its 6.9% range for 2015, and did so somewhat convincingly. What does this mean for Treasuries?

While the FOMC members rarely reference equity markets in public communications so as not to be seen as curmudgeons and to not risk their credibility on the vicissitudes of market psychology, there can be little doubt that the Fed does pay attention. One of the stated goals of quantitative easing was asset-price inflation, which was supposed to (and probably did) have positive wealth effects. When people feel richer because stock and home prices have risen, they spend more.

More recently, however, the Fed has seemed to move in the direction of concern about equity market valuations, with Fed Chair Yellen specifically referencing high biotech and media group valuations. It's even possible that financial stability goals (not blowing asset-price bubbles) have been part of the unstated reason for moving towards policy normalization. After all, with WTI crude set to drop below $40/barrel and wage growth restrained, what would the hurry be to raise rates, especially considering that the Fed has undershot its 2% goal for the PCE Price Index since mid-2012.

If emerging markets continue to decelerate, commodity prices remain low, equities decline, and the Fed continues to undershoot its inflation target, why the need to hike? The justification that it would be good to have some monetary ammunition to fire at the next economic slowdown makes no sense. Raise now so you can cut later? That only passes the laugh test if you believe that the power of interest rate cuts is mostly psychological.

Even if the Fed chooses to hike rates in September, the financial squalls that are forming in Asia could lead to a much lower and slower path for rate hikes than the 5-year yield (1.44%) is currently predicting. Economic expansions since 1857 have tended to last 42 months, according to Avondale Asset Management. We are now in our 6th year of expansion, so a rough patch would be in order.

- David Kelland, Briefing.com

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