A Faster Pace of Fed Rate Increases Could Rattle Markets
December 12 2017 - 3:11PM
Dow Jones News
By Ben Eisen, Daniel Kruger and Chelsey Dulaney
Investors have greeted the Federal Reserve's recent string of
interest rate increases with some of the most docile market
conditions in years, a sign that they could be in for a shock if
the central bank decides to ramp up the pace of rate rises next
year.
The Goldman Sachs Financial Conditions Index, a widely-watched
measure of how easily money and credit flow through the economy via
financial markets, was this month at its lowest level since 2014.
Financial conditions are now looser than they were before the Fed
began lifting rates in 2015.
Typically, the prospect of Fed rate increases tightens financial
conditions by pushing up borrowing costs for companies and
governments, lifting the value of the U.S. dollar against its
peers, and restraining a rise in the stock market.
But that hasn't happened this time around. Two years into the
Fed's rate-rise cycle, stocks have been on a near-uninterrupted
climb and longer-term Treasury yields have barely budged and
lingered near the technically-important level of 2.4% for much of
the past few months. The WSJ Dollar Index, a measure of the U.S.
currency against 16 peers, is down 3% from its December 2015
level.
Markets have rewarded investors who continued to take risks in
large part because the Fed has lifted rates more slowly than in
past cycles. After this week's expected increase, the Fed will have
lifted rates just five times in two years. By contrast, the Fed's
last tightening cycle stretched over a total of two years and
included 17 increases.
The Fed has been slow to move this time because the economy and
financial markets have shown few signs of overheating. Though there
are concerns in some corners that the prices of stocks and other
assets have climbed too far, the economy has been muddling along
and inflation remains below the Fed's annual target of a 2%
rise.
But that raises concerns about whether financial conditions will
tighten abruptly if the Fed opts to lift rates faster in the new
year. Jerome Powell is expected to take the helm of the central
bank in 2018, and could shift course, particularly with a new batch
of policy makers expected to favor faster rate increases. If
inflation begins to accelerate next year, the pace of rate increase
could also pick up, economists say.
Investors and central bankers had a long face-off with very
divergent expectations about how quickly growth and inflation would
pick up, and how much policy makers would need to do to address
improving conditions. After lowering their forecasts throughout
2016, Fed officials stuck to their guns in 2017, and the market has
moved toward the Fed's more recent, and less aggressive
projections.
Write to Ben Eisen at ben.eisen@wsj.com and Chelsey Dulaney at
Chelsey.Dulaney@wsj.com
(END) Dow Jones Newswires
December 12, 2017 14:56 ET (19:56 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.