At a certain point, higher stock prices could create a headache for the Federal Reserve, assuming bond yields remain subdued as well, according to economists at Evercore ISI.
It’s been one of the most hotly debated issues among economists over the past month: are higher stock prices incompatible with the Federal Reserve’s monetary policy ambitions?
While the Fed’s dramatic interest-rate hikes clearly impacted markets during the first half of the year, markets are complicated and influenced by myriad factors. Following the sharp selloff in stocks during the first half of the year, financial conditions have actually eased over the past month. As of Aug. 19, the national financial conditions index, published weekly by the Federal Reserve Bank of Chicago, had fallen to negative 0.28 from a peak of negative 0.14 on July 8.
When interest rates were at rock-bottom levels, market analysts used to talk about “the Fed put” — the notion that the Fed would step in to backstop the market if equity prices tumbled. Now that the Fed is in tightening mode, this relationship has become inverted, the Evercore team explained. Goldman Sachs Chief Economist Jan Hatzius said in a recent note to clients that while the Fed probably sees the easing in financial conditions as “unhelpful”, it hasn’t yet arrived at the point where the Fed would need to react with more aggressive rate hikes. Based on this view, Hatzius expects the Fed will raise its benchmark interest-rate target by only 50 basis points in September.
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