“You Should Take the Fed at Their Word”
“You Should Take the Fed at Their Word” by Wolf Richter – Wolf Street
Flip-flopping killed its credibility. That’s a problem for the markets.
“They’re getting more worried about the negative consequences of QE”: Fitch Chief Economist
The markets have been brushing off the Fed and have done the opposite of what the Fed has set out to accomplish. The Fed wants to tighten financial conditions. It’s worried about asset prices. It’s worried that these inflated assets which are used as collateral by the banks, pose a danger to financial stability. It has mentioned several inflated asset classes by name, including commercial real estate, which backs $4 trillion in loans heavily concentrated at regional banks.
And yet, markets have loosened financial conditions since the Fed started its tightening cycle in earnest last December. Markets are hiding behind “low” inflation, when the Fed is focused on asset prices.
So longer-term yields have been falling even as short-term yields have moved up in line with the Fed’s target rate, and thus the yield curve has flattened. The dollar has been falling. Equities have been soaring to new highs. And companies, if they’re big enough, are able to get funding for the riskiest projects at stunningly low rates.
“I think there is maybe too much confidence that the Fed is not really going to do too much more on interest rates, that we’ll have one or two more rate hikes and that’s it,” Brian Coulton, chief economist for Fitch Ratings, told Reuters on Tuesday.
Market participants are expecting “just one or two interest rate increases a year” despite the Fed’s stated expectation of seeing long-run interest rates at around 3.0%.
“When the Fed says they’re going to engage in a gradual rate of interest rate increases, they mean three or four rate hikes every year and we think that’s what they’re going to do,” Coulton said. “We think that you should take them at their word and it may even be a little faster than that.”
This disconnect between market expectations and the Fed’s stated intentions could create volatility in fixed-income markets when markets finally catch up, he said.