Professor Damodaran: Involvement Rates As Well As Stock Prices: It's Complicated!

From Professor D.'s Musings on Markets, March 2:

Jerome Powell, the novel Fed Chair, was on Capitol Hill on Feb 27, together with his testimony was, for the most part, predictable together with uncontroversial. He told Congress that he believed that the economic scheme had strengthened over the course of report of the terminal twelvemonth together with that the Fed would decease on on its path of "raising rates". Analysts convey spent the adjacent few days reading the tea leaves of his testimony, to determine whether this would interpret into 3 or 4 charge per unit of measurement hikes together with what this would hateful for stocks. In fact, the blame for the drib inwards stocks over the terminal 4 trading days has been placed primarily on the Fed bogeyman, amongst protectionism providing an help on the terminal 2 days. While in that location may hold out an chemical constituent of truth to this, I am skeptical almost whatsoever Fed-based arguments for marketplace increases together with decreases, because I disagree fundamentally amongst many almost how much ability key banks convey to laid upwards involvement rates, together with how those involvement rates impact value.

1. The Fed's ability to laid upwards involvement rates is limited

I convey repeatedly pushed back against the notion that the Fed or whatsoever key banking concern somehow sets marketplace involvement rates, since it actually does non convey the ability to produce so. The exclusively charge per unit of measurement that the Fed sets  directly is the Fed funds rate, together with piece it is truthful that the Fed's actions on that charge per unit of measurement ship signals to markets, those signals are fuzzy together with produce non ever convey predictable consequences. In fact, it is worth noting that the Fed has been hiking the Fed Funds charge per unit of measurement since Dec 2016, when Janet Yellen's Fed initiated this process, raising the Fed Funds charge per unit of measurement yesteryear 0.25%. In the months since, the effects of the Fed Fund charge per unit of measurement changes on long term rates is debatable, together with piece curt term charge per unit of measurement convey gone up, it is non clear whether the Fed Funds charge per unit of measurement is driving curt term rates or whether marketplace rates are driving the Fed.

It is truthful that post-2008, the Fed has been much to a greater extent than aggressive inwards buying bonds inwards fiscal markets inwards its quantitative easing efforts to maintain rates low. While that was  started every bit a reply to the fiscal crisis of 2008, it continued for much of the terminal decade together with clearly has had an impact on involvement rates. To those who would debate that it was the Fed, through its Fed Funds charge per unit of measurement together with quantitative easing policies that kept long term rates depression from 2008-2017, I would beg to differ, since in that location are 2 far stronger fundamental factors at play - depression or no inflation together with anemic existent economical growth. In the graph below, I convey the treasury bond charge per unit of measurement compared to the amount of inflation together with existent growth each year, amongst the divergence beingness attributed to the Fed effect:

Download spreadsheet amongst raw data

You convey seen me usage this graph before, but my indicate is a uncomplicated one. The Fed is less rate-setter, when it comes to marketplace involvement rates, than rate-influencer, amongst the influence depending upon its credibility. While rates were depression inwards the 2009-2017 fourth dimension period, together with the Fed did play a piece of job (the Fed effect lowered rates yesteryear 0.77%), the top dog reasons for depression rates were fundamental. It is for that argue that I described the Fed Chair every bit the Wizard of Oz, drawing his or her ability from the perception that he or she has power, rather than actual power. That said, the Fed effect at the start of 2018, every bit I noted inwards a post service at the get-go of the year, is larger than it has been at whatsoever fourth dimension inwards the terminal decade, possibly setting the phase for the tumult inwards stock together with bond markets inwards the terminal few weeks....MORE 

The practiced professor would every bit good similar to remind us:

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