Money & Banking

US Federal Reserve signals it isn’t afraid of ‘asset bubbles’

Reuters New York | Updated on September 17, 2020

It is acknowledging that the wealth effect of boosting risk assets is real, but is not a systemic risk, reckon investors

One key investor takeaway from Federal Reserve Chair Jerome Powell’s press conference on Wednesday: This central bank is not going to break a sweat fretting about future asset bubbles.

The Fed launched unprecedented support when the coronavirus pandemic hit the United States earlier this year, slashing interest rates and unleashing asset purchases which has pushed bond yields to lows and sent equity prices to record highs.

Still, Powell said the decade-long US economic expansion, which ran prior to the pandemic hitting growth, had included both quantitative easing and low interest rates but was “notable for the lack of the emergence of some sort of a financial bubble.”

“I don't know that the connection between asset purchases and financial stability is a particular tight one,” Powell said at a press conference after the Fed concluded a two-day meeting.

Also read: Fed touts economic recovery, vows to keep interest rates low

The central bank said on Wednesday that it would continue to purchase $120 billion in government bonds each month in order to support the economy and does not expect to raise interest rates until at least 2023 in order to let some inflation build in the economy.

The central bank’s balance sheet has remained steady at around $7 trillion since May as it has reduced some purchases of corporate bonds as spreads have tightened. Its balance sheet stood at approximately $4.29 trillion in the first week of March.

Echoes of 2008 response

The Fed’s policy closely resembles its approach following the 2008 financial crisis, which fuelled rallies in assets ranging from equities to real estate, said Scott Kimball, portfolio manager of the BMO Core Plus Bond Fund.

“The rally in the equity markets are the end result of a lot of actions that the Fed has taken along the way, and the Fed is acknowledging that the wealth effect of boosting risk assets is real but not a systematic risk,” said Scott Kimball.

The US benchmark S&P 500 is up approximately 51 per cent since its lows in March, bolstered in part by the US central bank's $3-trillion stimulus plan and move to slash interest rates to essentially zero. The index now trades at a trailing price to earnings ratio of 27.2, nearly double its historical average of 16, according to Refinitiv data.

“The Fed is telling investors that they are putting the monetary policy pedal to the metal,” said Brian Jacobsen, multi-asset strategist at Wells Fargo Funds, who said that he expects the US equity market to continue to rally, though at a slower pace than the past six months.

Still, there seemed to be some disappointment on Wednesday that the Fed had not gone further. There had been some hopes that the central bank was gearing up to extend the duration of its bond purchases, or ramp up asset purchases more generally, to keep longer bond yields lower and prevent an equity market correction.

Andrew Brenner, head of international fixed income at NatAlliance said the Fed was “nowhere near as dovish as many had thought” with no extension of asset purchases, no increase in buying of longer-end bonds and no yield curve capping, which alongside a view that the Fed will let inflation run, pushed up longer-end yields and hurt equities, he said.

Also read: Dollar rises after Fed's upbeat economic outlook

Benchmark 10-year Treasuries dipped, pushing yields up to 0.69 per cent from 0.67 per cent the day before, while the S&P 500 lost 0.46 per cent. 30-year Treasuries also dipped, with yields rising to 1.46 per cent from 1.43 per cent the day before.

Longer term, the Fed’s announcement on Wednesday helps the trends that were already in place, investors said.

“It underscores the idea that if you’re hoping to get some kind of yield in the bond market it is still many years down the road,” said Jason Ware, chief investment officer at Albion Financial, adding that as a result “it helps stocks look attractive on a relative basis.”

Published on September 17, 2020

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