The Federal Reserve is bent on normalizing interest rates from crisis-era levels. Who can blame policy makers for wanting to reassert policy order in an economy that no longer appears to require easy-money programs and is enjoying its lowest unemployment rate since 1969?
“The market is saying that the pace is a little too fast,” said Jeremy Siegel, professor of finance at University of Pennsylvania’s Wharton School of Business, and the man who forecast the Dow Jones Industrial Average DJIA, +0.40% would soon see 20,000 at the end of 2015.
Indeed, the Dow has shed about 950 points over the past two sessions, the S&P 500’s SPX, +0.53% skid on Tuesday marked its worst start to a Thanksgiving week of trade since 1982 and the Nasdaq Composite Index COMP, +0.89% is down 14.8% from its Aug. 29 closing record.
The Fed is widely expected to lift interest rates by a quarter of a percentage point at the conclusion of its two-day, rate-setting meeting on Dec. 19.
However, a number of other prominent market participants have warned that the Fed’s agenda is hurting asset values: “We’re in a situation right now that the Fed will have to look at asset prices before they look at economic activity,” Ray Dalio, founder of Bridgewater Associates, the world’s largest hedge fund, told CNBC last week in an interview. “It’s a difficult position.”
MarketWatch columnist Nigam Arora wrote in a recent article that the big question going forward for markets is: “Does the Fed relent or stay on its present course? If the Fed stays on its present course, expect P/Es to shrink.”
In other words, prices are likely to retreat as Fed tightening pushes borrowing costs higher for corporations. weighing on equity valuations.
Other market experts are predicting that evidence of sluggish growth abroad—for example, Germany economic growth skidded in the third quarter, producing its lowest rate of expansion since 2013—will force the Fed to pause its plans to lift rates aggressively in 2019.
Still, The Wall Street Journal’s Nick Timiraos and Gregory Zuckerman on Tuesday wrote that policy makers aren’t likely to comply with the market’s demand. “Speaking in Dallas last week, Fed Chairman Jerome Powell acknowledged the recent market selloff could reduce growth by tightening financial conditions, but he did not suggest it had been enough for the Fed to change its policy plans,” they wrote.
To be sure there are a litany of factors that have contributed to stocks getting knocked around in October and November, but many also have pointed to Powell’s early October remark that the Fed was a “long way” from a neutral rate as at least part of the cause for the current slide. The neutral rate is the theoretical rate at which the economy is neither boosted nor impeded. It is the point at which investors think that the Fed may cool its rate-hike pace.
Steve Goldstein writes that Powell may be signaling a more dovish, or accommodative, stance around neutral, with the Fed seeing the so-called neutral rate at around 3%, with the current federal-funds rate at a range between 2% and 2.25%.
Meanwhile, the benchmark 10-year Treasury rate TMUBMUSD10Y, +0.12% has been hanging below 3.10%, perhaps signaling that bond investors aren’t expecting a heightened pace of rate increases, even if a flight to safety has provided a floor for Treasurys. Bond prices fall as yields rise.
Perhaps the most vocal and influential critic of rate increases has been President Donald Trump, who has blamed Powell & Co., for undermining a business-friendly agenda that had led to repeated records for equity benchmarks.
Powell will get a chance to communicate where he stands on Nov. 28 when he speaks at the Economic Club of New York at 11:30 a.m. Eastern Time, and again he appears on Capitol Hill on Dec. 5, before the Federal Open Market Committee’s final convention of 2018.
Some Fed watchers have warned that Trump’s aggressive criticism could backfire, making policy makers reluctant to ease up out of fear it would appear they were cowing to criticism, undercutting their independence. But investors may not be satisfied until a course of a slackened pace is set.