Yellen left open the door for a March rate hike in her Semi-Annual Monetary Policy Report -- throwing in a Catch-22 problem for the stock market. A hike would seem likely if stocks stabilize or rebound. A hike might be avoided if the stock market continues to fall sharply. This conundrum suggests that market rallies should be sold.
Yellen essentially followed the message contained in the January FOMC Statement -- the economy is expanding moderately, the labor market is improving, inflation is low as a result of temporary factors, and monetary policy is expected to entail "gradual increases in the federal funds rate." While financial conditions have become less supportive and if persistent "could weigh on the outlook for economic outlook and the labor market," some of these conditions -- lower long-term interest rates and oil prices -- are supportive of growth as is labor income growth.
A Fed decision not to hike in March would seem to hinge on two main factors, based on these comments. First, US macroeconomic data would need to weaken notably. Second, financial conditions would have to weaken substantially further. In particular, the Fed appears to have thrown a gauntlet in front of the stock market -- if the market wants the Fed to skip a hike in March, it needs to fall significantly more. And, it would have to fall even more than otherwise if the dollar falls further on balance. Ironically, a notable weakening in the US macroeconomic data could be a positive for the stock market if they improve the economic outlook by persuading the Fed to skip tightening in March.
Carl Palash
Thoughtful comments. shouldnt a normal level of rates be GOOD news?
ReplyDeleteThanks. A normal level of rates is good if economic growth is at the potential rate and the economy is fully employed. But, there are two problems for the stock market when rates are pushed up by the Fed to a normal level: /1/ the increase in rates (independent of the level) hurts economic growth and /2/ there is likely to be a reallocation of resources when rates move up from a level that had been so low for so long. This "relative price change" hurts some sectors of the stock market more than others.
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