This past week 10-year treasury yields touched over 3.0% for the first time in four years, which many market participants attributed to corresponding decline in equity markets. While these short-term market movements are not very concerning, as we approach the 10-year anniversary of the start of the financial crisis—some of the parallels between yesterday and today are.
Comparing Bernanke and Powell
This past February 2018, Jerome Powell was sworn in as the Chairman of the Federal Reserve. Twelve years prior, in February of 2006, Ben Bernanke took on the same position as the head of the Fed. When Ben Bernanke landed his role, he was handed a red-hot economy with GDP growing at 3.3% in 2005 and 2.7% in 2006. In his very first meeting as chairman, housing was a prime area of concern as housing prices had risen by 41% over the past three years leading into 2006. Rates were already on a gradual rise when Bernanke took office and in its first meeting chairing the FOMC, they decided to raise rates inline with the step pattern from before. For anyone not following along, Powell entered into his role with rates already on the rise and raised rates in his first meeting too.
Examining the transcript from Bernanke’s first meeting, interestingly one of his arguments for raising rates was his thought that “we could think of our policy in terms of the mortgage rate rather than the funds rate” and that “if we failed to act today...we would create a rally in the long term bond market and in the mortgage market.” Today long term yields continue to be a point of great interest, raising concerns for their implications for the mortgage market and thus housing. But today, the focus is also on US equities, which have risen 32% just between 2016 and 2018.
BIS sounds an alarm
Four years ago, the Bank of International Settlements, the world’s central bank, started their annual report in 2014 with a direct headline “Global financial markets under the spell of monetary policy.” For a media report, this headline would be tame, but for an institution that is owned and operated by central banks globally, the headline provided a concerning alarm to central bankers that extraordinary low interest rates and rising central bank balance sheets were overly influencing financial markets. Of course, the BIS was influenced by the Taper Tantrum from the prior summer of 2013 and declining risk premia globally.
Four years later some may believe the spell of monetary policy has been lifted. The Fed has raised rates six times and markets have adjusted well. The balance sheet of the Fed is already starting to gradually decline, and the markets have managed through two leadership changes. If anything, the market seems asleep, or more likely intoxicated. Indeed, today the Robert Shiller’s CAPE index values the S&P 500 at around 32 times earnings, which is well above the long-term mean of 15. Last year there was almost 2,000 IPOs globally that raised more than $330 billion, the greatest IPO level of activity since 2007. At the same time private equity assets under management have grown significantly, doubling in the last decade from $1.5 to $3.0 trillion with an estimated $1 trillion sitting in cash.
As Powell stares out at the risks on the horizon, instead of assuming that the gradual normalization of policy is working, he should remember the spell of monetary policy and the significant implications they may have had on risk appetite, risk markets, and beware of the moment the spell eventually wears off.