Monday, May 11, 2015

Nomi Prins - Market reaction to Janet Yellen

In this Forbes article Nomi Prins talks about recent comments by Fed chief Janet Yellen and how to read the market reaction to them. The article notes that in her comments about causes for the last financial crisis, she seemed to overlook any role the Fed might have played. Below are some quotes and then a comment.


Yesterday, stock and bond markets dipped on the news that Federal Reserve Chair Janet Yellen said that “equity market valuations at this point generally are quite high.” She further noted, “There are potential dangers there.”

She did not go so far as to say that she saw any market bubble. That would be akin to admitting that something drastic – and well, more immediate – would be required to address said bubble. Instead, she said, “The risks to financial stability are moderate, not elevated at this time.“
. . . . .
"Regarding the financial crisis of 2008, Yellen noted that, “A combination of responses to distorted incentives by players throughout the financial system created an environment conducive to a crisis.”
That is certainly true, but it is equally true that those players were incentivized by the same elements then, as they are now – low rates that drive the innovation and distribution of ever-riskier securities in order to reap requisite profits.
Yellen remarked that policy makers, “remain watchful for areas in need of further action or in which the steps taken to date need to be adjusted.”
This isn’t particularly comforting in light of how the Fed missed the complex asset bubbles that were predicated on the housing and subprime loan market bubbles last go-around. Greater proactivity is in order, as opposed to reactionary behavior.
It is the Federal Reserve’s zero-interest-rate policy that bolstered the markets, led to historically high corporate share buybacks to enhance them further, caused yield seekers to have the cheap money and associated motivation to invest in higher yielding, riskier securities, and propped banks’ incentives to finance it all.
Admitting anything less than an active role in the level of markets now, is a bit like serving a group of dieters large helpings of gooey cake and commenting on how portly they appear afterwards. Janet Yellen isn’t wrong in her diagnosis; she’s just missing, or sidestepping, the Federal Reserve’s past and ongoing role in the entire situation. That’s a problem in and of itself."

My added comments:

This article has a number of observations about the interaction between the policies of the Fed and markets. Of course we are not surprised that any role the Fed might have played in contributing to the financial crisis is ignored in the comments by Janet Yellen. You would not expect her to criticize the Federal Reserve.

What is obvious is that we now live in a world where markets are so tied to Fed policy that they react to whether or not the word "patience" shows up in the Fed statement. A real economy based on real fundamentals would not behave like that so it reminds us that we still do not have a real economy standing on its own two feet without easy monetary policy support. We won't find out about that until the Fed actually raises interest rates more than just a token amount.

No comments:

Post a Comment