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Summary

  • The Board of Governors of the Federal Reserve System did nothing at its meeting this week that was not expected by market participants.
  • As a consequence, the market responded positively with several new record highs and lower volatility.
  • Asset price inflation remains good because it increases economic wealth, although it hasn't done much for economic growth.

There are two things that have been discussed more and more in the press recently that investors are really worried about.

The first of these is about the timing of the Federal Reserve's decision to begin to increase short-term interest rates.

The second is about the possibility that the inflation in consumer prices might finally be starting and officials at the Fed will get all "bothered" about the chance that price inflation might begin to trend upwards.

Asset price inflation… bubbles… not to worry.

When the results of the Board of Governors meeting of the Federal Reserve System were announced on Wednesday, cheers rang out on Wall Street and beyond.

On Wednesday, stock market prices just "hung around" until the release of the Fed's statement.

At the close of business on Wednesday, the Dow Jones Industrial Average registered a daily increase of almost 200 points, and the Standard & Poor's 500 Stock Index hit a new closing record.

On Thursday, stock prices remained relatively quiet, although the S&P 500 hit another historical high.

Friday, both the Dow Jones Industrial Average and the S&P 500 hit new records!

At least for the time being, investors could feel safe with elevated levels of stock prices because there was no indication that the Federal Reserve had any intention of upsetting the apple cart in the near future.

Anyhow, higher stock prices mean that citizens of the United States have more wealth and, according to many official economic models, more wealth means that there should be more spending in the future -- spending that would help to spur faster economic growth and lower levels of unemployment.

So, I believe the Federal Reserve got what it wanted -- a continuation of economic calm and stability.

Another good sign for the Fed was the decline in the measures of stock and bond market volatility also fell fairly dramatically after the Fed's announcement on Wednesday.

These measures were another sign of how placid investors have been in that these measures, even before the Fed announcement, registered lows that had not been seen for a long, long time. A lot has been made of these lows in the press recently. Well, now, the volatility of these markets have declined even further.

But markets also registered some other movements that indicated that investor concerns about rising inflation, even if very modest, were increasing.

For one, inflationary expectations as measured in the bond market jumped up Wednesday and rose further on Thursday and Friday. The increase was not that major, but it was dramatic given that the timing came right after the Fed's announcement, and that the move was from a near-term low that had been in place for the past two months.

Furthermore, there were significant jumps in certain foreign exchange markets. The value of the euro and the British pound relative to the US dollar both jumped beginning on Wednesday.

The value of the euro rose above $1.3600 on Wednesday after it had fallen recently due to the actions of the European Central Bank. The value of the British pound jumped above $1.700 for the first time in a very long while. This latter move has been helped by statements of Mark Carney, Governor of the Bank of England that short-term interest rates in England needed to rise.

The final piece of evidence that I would like to mention is that the prices of gold and silver both jumped after the announcement of the Federal Reserve. The price of gold had reached lows in the $1240s in early June. On Friday, gold closed above $1315.

The bottom line in all this analysis is that the Federal Reserve is dominating the financial markets and investors very well realize it.

Oh, by the way, the Board of Governors did agree to reduce its monthly purchases of securities by another $10.0 billion. The monthly total is now set to be $35.0 billion.

Note that this does not mean that what the Federal Reserve is doing is having much of an impact on real economic activity, and investors also seem to very well realize this fact. Just to confirm this situation, the Federal Reserve did revise downwards, as expected, its projection as to the future real growth rate of the economy to the 2.1 percent to 2.3 percent range, bringing it more into line with the forecast of the US Treasury Department and others.

So, for the time being, financial markets remain placid and "follow the Fed."

Source: Market Shows Relief After Federal Reserve's Latest Board Actions