Fed May Raise Rates Later This Year, Ho-Hum - But What About Asset Prices?

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Summary

The Federal Reserve decided not to raise interest rates at this time but indicated that it may find reason to raise them later on this year if data supports it.

One bit of data the Fed doesn't seem to reflect upon is asset prices, something that others are concerned about given the historic levels of stock prices.

Unfortunately, confidence in Fed leadership is the lowest I can remember and current efforts to provide "forward guidance" do nothing to improve this situation.

Where have I heard this before? The Fed thinks it may raise interest rates sometime this year, possibly even in September. Janet Yellen and other Fed officials are making a joke out of "forward guidance." It might be funny, if we had not been getting such "forward guidance" for almost two years now.

Unfortunately, Janet Yellen and the current Fed are losing all sorts of credibility. I have not felt such disdain for the Federal Reserve in my whole professional career. Will the Fed raise its policy rate of interest this year? Or, not? Will the data drive the Fed to move interest rates? Or, not?

The Fed is just flip-flopping on each monthly, weekly, or daily release of data. What good does this do markets? And, yet the Fed has done one thing.

The Fed, while its officials have been bouncing all over the place, has accomplished one thing. With investors working on the market principal that one should not "fight the Fed," money has flown into the stock market bringing stock market indices up to new historically high levels.

Greg Ip brings this subject up in the Wall Street Journal: "Economy Is Back Under Sway of Asset Prices."

The title of the chart that accompanies the article by Mr. Ip is, "Here We Go Again." This highlights the substantial increases in stock prices, home prices, and the rising net worth of Americans coming from these rising prices.

Of course, this is right in line with what the Fed has wanted to achieve. Particularly Ben Bernanke, former Chair of the Board of Governors, believed very strongly in something called the "Wealth Effect."

The wealth effect has to do with the effect that rising household wealth has on the consumption expenditures. Mr. Bernanke believed that if the Fed could raise stock prices and housing prices, consumers would begin to spend more rapidly and this would spur on the economy to faster growth.

Certainly, consumption expenditures have been the strong point of the seven years of the current economic expansion and continues to be the major driving force.

The problem is that this expenditure has not spilled over into business investment expenditures.

And, if the stock market is any gauge of what is benefiting from the stimulus, the results in consumption expenditures has not really been that productive.

Over the past four years or so, I have taken to watching how various sectors of the stock market have performed. The information I have gathered is from Barron's weekly Market Laboratory-Stocks, information.

Investors apparently believed Fed Chair Bernanke because during most of this time, the two sectors that were at the top of the list of top performers were… Consumer Goods and Consumer Services.

But, going further, it is not altogether clear that the subsectors within these two top performers were exactly what Mr. Bernanke and the Fed wanted. In my posts, I listed the top fifteen subsectors and usually there were seven or eight of the top performers from these Consumer Goods and Consumer Services.

These top performers included Breweries and Distilleries, Restaurants, Toys, and other non-essential areas. Certainly, not areas that would lead other businesses to invest in new capital equipment.

So, it appears that Mr. Bernanke and the Fed got its wealth effect and got consumers spending and this was reflected in the choice of businesses that the stock market rewarded. But, it built little or no excitement for greater business expansion.

And now, you have Mr. Ip leading off his article with this: "The past two recessions were ushered in by asset-price collapses. The risk of a repeat is growing." Is Mr. Ip thinking that current asset price levels might reflect an asset bubble?

Mr. Ip does provide some research that indicates that "instability" in the economy "emerges when wealth growth slows to below that of income." He continues, "That has already happened."

"Despite their recent record, stocks aren't much higher than a year ago. Profits are down, too."

"It doesn't mean a recession is coming: but it's a vulnerability the Fed should keep top of mind."

Yet, asset prices don't seem to be on the Fed's radar when discussing current data.

Just another piece of information that adds to our confidence in the current Fed leadership. So much for current Fed "forward guidance." Now we need to keep an eye on the Fed's balance sheet to see how they might be positioning itself.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.