That’s the question Hilsenrath asks in his latest piece.
He notes that if the short end is the marker for inflation and the longer end reflects flows into dollar assets, those flows could spark an asset price boom prompting the Fed to act sooner or more aggressively than expected.
He cites a speech by William Dudley talking about the how the Fed may have had the wrong reaction to lower long end rates in 2000.
“During the 2004-07 period, the (Fed) tightened monetary policy nearly continuously, raising the federal funds rate from 1 percent to 5.25 percent in 17 steps. However, during this period, 10-year Treasury note yields did not rise much, credit spreads generally narrowed and U.S. equity price indices moved higher. Moreover, the availability of mortgage credit eased, rather than tightened. As a result, financial market conditions did not tighten. As a result, financial conditions remained quite loose, despite the large increase in the federal funds rate. With the benefit of hindsight, it seems that either monetary policy should have been tightened more aggressively or macroprudential measures should have been implemented in order to tighten credit conditions in the overheated housing sector.”
Overall he makes the case that while there’s plenty of arguments for why long term rates are falling (slower global growth, falling oil), there’s also counter reasons, such as a strong dollar and rising stock prices attracting foreign capital, as to why the Fed might act more aggressively.
If anything arguments on both side of the fence are valid and we’re seeing that quandary in markets at the moment. While those arguments continue the market will go sideways until a winner emerges.
The WSJ piece is here (possibly gated)
