Goldman Is Troubled By The Fed's Growing Warnings About High Asset Prices

With both the S&P, and global stock markets, closing last week at new all time highs, it is safe to say that any and all warnings about "froth", and perhaps a bubble in the market, as Deutsche Bank characterized it last week have been ignored. And yet, as Goldman's economist team writes over the weekend, the recent rise in warnings about "risk levels" and asset prices by Fed officials is concerning: "Fed officials have expressed greater concern about asset prices and financial stability risk recently, a change from their more relaxed view last fall. In particular, the minutes to the June FOMC meeting highlighted concern about high equity valuations and low volatility and drew a connection between potential overheating in the real economy and financial markets."

To underscore this point, here is a recap of recent Fed warnings about asset prices, which have increased significantly since the presidential election:

Janet Yellen, July 12, 2017

So in looking at asset prices and valuations, we try not to opine on whether they are correct or not correct. But as you asked what the potential spillovers or impacts on financial stability could be of asset price revaluations — my assessment of that is that as assets prices have moved up, we have not seen a substantial increase in borrowing based on those asset price movements. We have a financial system and banking system that is well capitalized and strong and I believe it is resilient.

FOMC Minutes, July 5, 2017 the assessment of a few participants equity prices were high when judged against standard valuation measures...  Some participants suggested that increased risk tolerance among investors might be
contributing to elevated asset prices more broadly; a few participants expressed concern that subdued market volatility, coupled with a low equity premium, could lead to a buildup of risks to financial stability... Several participants expressed concern that a substantial and sustained unemployment undershooting might make the economy more likely to experience financial instability or could lead to a sharp rise in inflation that would require a rapid policy tightening that, in turn, could raise the risk of an economic downturn.

Janet Yellen, June 27, 2017

Asset valuations are somewhat rich if you use some traditional metrics like price earnings ratios, but I wouldn't try to comment on appropriate valuations, and those ratios out to depend on long-term interest rates.

John Williams, June 27, 2017

The stock market seems to be running pretty much on fumes... so something that clearly is a risk to the U S economy, some correction there, is something that we have to be prepared for and to respond to if it does happen. The U S economy still is doing — I think on fundamentals — is doing quite well. So I'm not worried about some kind of late- '90s, dot-corn bubble economy where a lot of the underpinnings were driven by the stock market.

Bill Dudley, June 23, 2017

Monetary policymakers need to take the evolution of financial conditions into consideration... For example. when financial conditions tighten sharply, this may mean that monetary policy may need to be tightened by less or even loosened. On the other hand, when financial conditions ease - as has been the case recently - this can provide additional impetus for the decision to continue to remove monetary policy accommodation.

Stanley Fischer, June 20, 2017

House prices are now high and rising in several countries, perhaps as a result of extended periods of low interest rates.

Janet Yellen, June 14, 2017

We're not targeting financial conditions. We're trying to set a path of the federal funds rate, but taking account of those factors and others that don't show up in a financial conditions index.

Robert Kaplan, June 30, 2017

That's not to say these imbalances won't build and I am concerned that they may but if you ask me today I think right now it's manageable, but I do think if there were some correction also in the markets. that could actually be a healthy thing.

Neel Kashkari, May 17, 2017

Monetary policy should be used only as a last resort to address asset prices, because the costs to the economy of such a policy response are potentially so large.

Eric Rosengren, May 8, 2017

While I am certainly not expecting such a scenario to occur, central bankers are charged with thinking about adverse risks to the economy. So current valuations in real estate are one such risk that I will continue to watch carefully.

Jerome Powell, January 7, 2017

With inflation under control. overheating has shown up in the form of financial excess. The current extended period of very low nominal rates calls for a high degree of vigilance against the buildup of risks to the stability of the financial system.

Perhaps their concern is due to the following Citi chart which we have discussed on numerous occasions, and which shows the "incredible" correlation between global central bank balance sheet size and market returns in recent years.

Or perhaps the Fed is not worried about stock prices at all, and while the recent commentary about asset valuations is notable, what the Fed is really concerned about is the recent pick up in the unemployment rate, something which as Bank of America noted last week, "there are no episodes in which unemployment rose a bit and remained stable at its natural employment rate. Rather, a recession has always followed."

Whatever the reason for this unexpected shift in rhetoric, here are some additional summary observations from Goldman, which while pointing out that such comments by Fed members are quite unorthodox, "Fed officials do appear more concerned about financial stability risks, and this could strengthen the case somewhat for tightening in the future."

  • Traditionally, Fed officials have thought it wisest to respond to financial variables through their forecasted impact on inflation and employment. They have taken a more skeptical view of using the funds rate to lean against stretched valuations, though they have not closed that door entirely.
  • We find that the Fed has largely followed these principles in practice, responding primarily not to valuation levels but rather to something like our FCI growth impulse, an estimate of the impact of recent changes in financial conditions on the growth outlook. Currently, the FCI growth impulse points to a healthy boost over the coming year, strengthening the case for further tightening.
  • Leaving financial instability concerns out of the reaction function does not mean the policy stance has no role in reducing these risks. Our cross-country model of asset price busts shows that bust risk is substantially higher when the output gap is more positive, supporting the concern noted in the June minutes. This suggests that if the Fed is successful in containing overheating in the real economy, it can breathe at least a little easier about bubble risk.
  • To what degree might the FOMC view financial stability risk as an independent argument for higher rates? Research by Fed economists suggests that because credit growth has been only moderate, the optimal response of the funds rate to financial instability risk is very small. But this could cut both ways: the economy’s reduced dependence on debt relative to the last two cycles also implies less risk that moderate tightening will lead to a crash.
  • At this point, the FOMC does not need additional reasons for gradual further tightening, which a traditional reaction function based on the dual mandate suggests is already warranted. But Fed officials do appear more concerned about financial stability risks, and this could strengthen the case somewhat for tightening in the future.

The quandary would be promptly resolved, of course, if in the ongoing increasingly nebulous relationship between the Fed's policy intentions and record high stock prices, which as Kevin Muir summarized simply as "stocks dare the Fed", and are "about to make Dudley, Fischer and Yellen extremely nervous", the Fed were to defy markets and unexpectedly hike rates once again, responding to the "dare", and making it clear that the Fed is indeed focused first and foremost to threats to financial stability resulting from market "froth" and "bubbles"... which incidentally it itself has created.


All Risk No Reward Stuck on Zero Sun, 07/16/2017 - 13:45 Permalink

The Debt-Money Monopolists are running a debt-money bubble / debt-money bust societal asset stripping operation.

The debt-money bust is just as important, and just as inevitable, as the debt-money bubble.

The Roaring 20s only existed to create the cause of the Great Depression 30s...

The Federal Reserve is manned by employees.

It is a chess piece.

If you can't envision the CHESS MASTER, well, you failed if your effort was to resist and enemy you can't even envision.

In reply to by Stuck on Zero

swmnguy All Risk No Reward Sun, 07/16/2017 - 14:05 Permalink

You are correct, Sir.  If there weren't a takedown in the works, Wilbur Ross wouldn't be Secretary of Commerce.  All that guy has ever done is large-scale bankruptcy and liquidation killjobs.  Now to crown his career in fitting fashion, he gets to preside over the biggest B&L of all time.  The entire Administration is in place for just this; they're all either experts in military and civil action against civilians, and asset-stripping.Just as you'd only hire a plumber to fix your plumbing, or an auto mechanic to work on your car, you'd only put this crew in charge if you're going to do a major looting of the biggest financial prize to be had in history.

In reply to by All Risk No Reward

lester1 Sun, 07/16/2017 - 12:14 Permalink

EVERYONE NEEDS TO STOP WORRY ABOUT STOCKS. THEY ARE PROGRAMMED TO ONLY GO HIGHER! These stock market gains are not real people buying. It's the Fed's plunge protection team, aka PPT who are covertly buying stocks so that the rich stay rich and pension plans and 401ks stay propped up!.. If they didn't buy stocks and bonds we would see an epic crash that makes 1929 look like a picninc. Politicians +Trump would call to end the Fed! Why else did Janet Yellen say there won't be another crash again in our lifetime ?? She knows PPT will save the day and keep her assets prices propped up too.

Cordeezy (not verified) Sun, 07/16/2017 - 12:21 Permalink

The Asset prices will remain inflated as long as interest rates remain low, that is how it works.... then when they raise interest rates, the bubble will burst causing a correction and asset prices to normalize.  This will mean the fed will have to lower the rates again to save the economy which will start another asset bubble beginning that will last for another 7-10 years until we are having this same conversation again.  The question now is, at what point will the bubble of today burst?

order66 Sun, 07/16/2017 - 12:22 Permalink

30% chance of recession from the Fed forecast has always been followed by a recession. It's at 10% now and headed up.On the other hand, you simply won't see stocks go down until buybacks stop.Period.

Deep In Vocal … (not verified) Sun, 07/16/2017 - 12:28 Permalink

a lot of words......asset prices are low asset prices are high....the mafia playing games with the ordinary citizen.....the ordinary citizen are totally fucking clueless about what's going on...head in the sand and upload picture of breakfast to facebook.....  

NihilistZerO___ onthedeschutes Sun, 07/16/2017 - 12:51 Permalink

I really doubt we'll see torches and pitchforks. There is no threat to the food supply chain or availability of energy. If anything this next correction will be like the early 90's recession. If you were in the workimg class you were relieved as the inflation of the late 80's receded. The S&L Crisis was basically Housing Bubble Beta and was the first of the 3 great busts of the modern era Fed preceeding the tech bust and Housing Bubble 1.  For 80% of America 2011 was better than today. Sure their were a few less jobs, but housing costs were radically lower. Unless you recently got into assets this recession will be welcomed.

In reply to by onthedeschutes

Consuelo NihilistZerO___ Sun, 07/16/2017 - 13:14 Permalink

  Ask yourself - with today's mainstream media, if you will be informed of any supply-chain disruptions in time enough to do anything about it...?There is the veneer of normalcy and stability that your eyes see on a daily basis.  Then there is what is underneath that veneer.  Similar to a volatile magma pool that sends out a quake here & there and some smoke & steam, but nothing to be worried about - it's been doing it for hundreds of years, right...?

In reply to by NihilistZerO___

khakuda Sun, 07/16/2017 - 12:46 Permalink

The reality is that they never had any intention of raising rates.  Normalized inflation long term probably runs from 2 - 4% and short rates should average somewhat over that amount over the long run.  Rates are still at only 1% - a level which was considered a short term emergency level 15 years ago and a rate still well below actual current inflation over the past year or two.The Fed has been responsible for every bubble, including the current one.

PUNCHY khakuda Sun, 07/16/2017 - 12:53 Permalink

The sad reality is that these genius pissers have painted themselves into a corner and now, despite their strutting Phd conceit they haven't a bloody clue as to how they will wangle themselves out of this self-inflicted disaster. The greater tragedy of course is that you and I are the ones to ultimately suffer from their reckless arrogance!

In reply to by khakuda

Lost in translation Sun, 07/16/2017 - 12:58 Permalink

Told the Mrs. that all of the career pimps, effete douchebags, and institutional thieves are all hustling to play the Cassandra role, now. "Why's that?" she says...

1. Plausible deniability: "Don't blame me! I WARNED you!"

2. Make the "in-studio guest" speaking circuit, where they expound their mystical powers of market prophesy.

3. Gain an even greater following of client-muppets for the inevitable lather/rinse/repeat cycle.

Herdee Sun, 07/16/2017 - 15:11 Permalink

You'll notice that there's not one of the Keynesian gang that wants to deal with, let alone mention, which is the Velocity of Money. It is quickly approaching a big fat zero. If everything is so great (which it's not), the velocity of money would be moving quite rapidly and higher. It's falling dramatically. Something has to give.

Batman11 Sun, 07/16/2017 - 18:14 Permalink

It is a pity Ben Bernanke didn’t study the cause of the Great Depression rather than the Great Depression itself.The 1920s roared with debt based consumption and debt based speculation before everything tipped over into the Great Depression. and 2008 stick out like sore thumbs; bank credit going into financial speculation and stocks (1929) or real estate (2008).Leveraged financial speculation with bank credit.If he’d studied the bit before 1929, rather than the bit after 1929, all this unpleasantness could have been avoided.

TrainReck Sun, 07/16/2017 - 19:01 Permalink

So FED officials' viewpoints have changed from being more "relaxed" since last fall. That's all you need to read. It's the sentiment that they know the "game" has almost run it's course. Just skip all the rest of the bullshit rhetoric. For so many years it's always been how many different freakin ways can you spin it FED talking heads? And now we've got Trump spewing the same lying b.s. to the masses. Jobs, jobs, jobs & can you believe the current Stock Market rally since I was elected? Make America Great Again!

Charvo Sun, 07/16/2017 - 20:04 Permalink

I think the Fed is going to put in place its reverse QE pretty soon.  This is what I think the treasury bond market is saying.  Look at the TLT.  A breakdown of the recent lows would be like almost a waterfall.  Someone made a big bet on treasury volatility expiring on July 21st. Yellen specifically talked about long-term interest rates being too low.  This is a reason for the valuations for the stock market being elevated because these algos use interest rates as part of their asset allocations.  Yellen is going to make the long end of the curve rise at least until she is kicked out in 2018. This would force the yield curve up.  Keep short rates somewhat stable and destroy the treasury bonds.  Dividend stocks and utilities will have problems.