The latest minutes from the Federal Reserve’s mid-June meeting, released on Wednesday afternoon, revealed that the Fed acknowledges financial conditions have eased despite reduced policy accommodation.
“Participants observed that, over the intermeeting period, equity prices rose, longer-term interest rates declined, and volatility in financial markets was generally low,” according to the minutes.
Investors have been trying to decipher if the Fed’s underlying tone is “hawkish,” which would suggest a higher likelihood of aggressive tightening, despite recent concerns including low inflation readings and softer economic data.
The scrutiny on the Fed’s tone grew stronger following the Fed’s decision to boost its benchmark interest rate 25 basis points in June for the second time this year, particularly as central bankers across the world expressed more hawkish commentary.
Following the release of the minutes, bond yields rose to a seven-week high and market expectations for the fed funds rate also increased, suggesting the market is pricing in tighter Fed policy this year.
Some participants said stock prices were ‘high’
When Fed participants discussed why financial conditions had not tightened, the conversation turned to asset prices.
“Participants discussed possible reasons why financial conditions had not tightened. Corporate earnings growth had been robust; nevertheless, in the assessment of a few participants, equity prices were high when judged against standard valuation measures,” according to the minutes.
In other words, it seems the Fed has been looking beyond merely its dual mandate of achieving stable prices and maximizing sustainable employment.
“Some participants suggested that increased risk tolerance among investors might be contributing to elevated asset prices more broadly,” according to the minutes. “A few participants expressed concern that subdued market volatility, coupled with a low equity premium, could lead to a buildup of risks to financial stability.”
Last week, public statements from Fed officials focused on the markets and valuation.
San Francisco Federal Reserve Bank President John Williams said the stock market is “running on fumes,” Yellen mentioned “somewhat rich” asset prices, and Federal Reserve Vice Chairman Stanley Fischer warned against complacency.
And RBC’s chief US economist Tom Porcelli said this focus on valuation makes sense.
“What we learned not only from the last cycle (the housing bust) but from the one before that (the pop of the internet bubble and subsequent credit dislocations) is that dis-inflation is not what ultimately takes the economy down. It is about asset bubbles that, one could argue, were led on by ultra-easy monetary policy and then pricked by tightening on the follow,” Porcelli wrote in a recent note.