Financial Matters | An Article by Biz Alum, Barry Nielsen
For the last several years U.S. financial markets have had two big forces pushing and pulling on prices; Federal Reserve policy and economic reality. At times these forces have aligned. At other times they have taken prices in opposing directions.
As an example, even with recent volatility stock prices remain within range of all-time highs while bond yields and interest rates are near all-time lows. That alone suggest something is not quite right in markets. Rising stock prices should reflect a strong economy and bright economic prospects. In such an environment one might expect bond yields and interest rates to rise, which they have not.
Many times over the last few years analysts and the financial press have said, “The 30 year secular trend toward lower interest rates has ended. We have seen the low in interest rates.” That is yet to play out.
Last December the Federal Reserve did raise short-term interest rates for the first time in 9 years, but longer-term interest rates almost immediately went in the opposite direction. The yield curve has flattened which is not a good sign for the economy.
The Federal Reserve thought both the economy and markets were ready to stand on their own when they raised the Federal Funds rate in December. Financial markets are not so sure.
It is difficult to know exactly where the economy stands, and how markets will react to both incoming economic news and changing interest rate policy from the Federal Reserve.
At times over the past several years bad economic news has actually been good for market prices because it meant that the Federal Reserve would likely continue to use extraordinary measures such as large scale bond purchases, also known as quantitative easing, to stimulate economic growth and support financial markets.
At other times bad economic news has actually been bad for markets.
For much of the last several years markets have come to rely upon what is known as the “Greenspan, Bernanke, or Yellen Put,” a reference to downside protection available in option markets by buying put options. In other words, “don’t worry, the Federal Reserve will not let prices fall.”
For the last several months that story seems to change daily. On some days good economic news causes stocks to rally, and bonds to sell-off. On other days the opposite is true.
Certainly foreign economic events and foreign central bank policy are having an impact on U.S. markets and the U.S. economy.
The Bank of Japan and the European Central Bank, foreign equivalents of the U.S. Federal Reserve, have gone all in with negative interest rates and large scale asset purchases. China continues to nationalize non-performing loans to mask their huge debt problem. The rest of the world is counting on the U.S. to pull their economies out of what is feared to be a troubling downward deflationary spiral.
The end result is, over the last several years, market prices have been distorted by central bank asset purchases and policies. The Bank of Japan continues to buy stocks, or at least stock funds, and the European Central Bank recently announced that they will start to buy corporate bonds. At the same time markets are losing confidence that any of it will actually stimulate economic growth. As the Federal Reserve tries to “normalize” monetary policy in the U.S., incoming economic data continues to show mixed results. Expect volatility in markets to continue as investors search for prices which reflect economic reality.
Barry Nielsen has worked in capital markets for over 20 years with a focus on fixed income portfolio and risk management. He has an MBA from George Mason University and holds the Chartered Financial Analyst designation. He currently works for Opportunity Bank of Montana.
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