An Urban's Rural View

Markets Ride the Federal Reserve Roller Coaster

Urban C Lehner
By  Urban C Lehner , Editor Emeritus
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It's happened again. Nearly eight years after the 2008 meltdown, financial markets continue to ride the Federal Reserve roller coaster. They thrive on hopes of easy money. When the Fed dashes those hopes, the falls can be stomach churning.

Wednesday May 18 was the scene for one of those steep, sudden drops. That was the day the central bank released the minutes of its April meeting, which indicated an interest-rate increase at its June meeting is a real possibility. Markets reeled. Government bond prices took their biggest hit of the year, gold plummeted and the dollar rose 0.8%.

And the ride may continue. At the very least, now that the Fed has put tightening back on the table, volatility seems likely to pick up. The markets' "fragile stability may be coming to an end (…)," the Wall Street Journal theorized on the day of the release. While stocks bounced back a bit two days later, yields on Treasuries and the dollar ended the week higher.

You'd think the markets would have taken the news more in stride. It's not like the Fed said flatly it would raise rates in June. There was an "if" -- "if incoming data were consistent with" economic growth picking up, labor-market conditions continuing to strengthen, and inflation moving toward the central bank's 2% target (…). That's a big if.

Nor did the minutes reveal any major change in the Fed's overall thinking. Markets have long known that the Fed is looking to raise rates at some point -- and known too that the decision on when to raise them will hinge on pickups in economic growth, employment and inflation. The Fed has made clear its moves will be "data-dependent."

Moreover, markets know the next increase will be small and the new, higher rate will still be very low -- a federal funds rate of less than 1%.

So what's going on? Why did markets react so badly? In a nutshell, markets have had a more pessimistic view of the economic outlook than the Fed, and their pessimism had led them to assume a rate increase wouldn't happen soon. There are indications in the meeting minutes that some Fed policy makers were concerned about this assumption and wanted to fire a warning shot across the markets' bow.

The message was received. In the wake of the release of the minutes, futures traders put a 34% probability on a June rate increase, up from 4% a few days earlier. If you had to guess why the probability wasn't put even higher, it's likely it was only because there may not be enough new economic data before the June meeting for the data-dependent Fed.

For farmers and ranchers, this back-and-forth between the central bank and the markets may seem academic. After all, the bottom line is unchanged: Interest rates are likely to remain relatively low for some time to come, even if they go up a little sometime in the next few months.

In another way, though, it matters a lot. When the bond market sees higher rates coming, it does some of the rate-raising work for the Fed. This time, the bond market reacted to the minutes with a 0.123 percentage point increase in the 10-year Treasury note's yield.

And rising Treasury yields boost the dollar's value, which saps commodity prices and export competitiveness. Although the dollar has weakened in recent months after several years of strengthening, that may not continue. With Treasury rates rising and the Fed preparing for increases even as central banks in Europe and Japan are pushing rates into negative territory, the stage seems set for a stronger dollar.

If there's any comfort in this, it's that time and again the Fed has shown that while it wants to get monetary policy back to normal, it doesn't want to cause a market collapse. It may fire warning shots and may eventually even raise rates, but it will proceed cautiously. And the markets know this.

Still, at some point soon somebody needs to say, "Stop the roller coaster. We want to get off."
Urban Lehner



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5/31/2016 | 11:51 AM CDT
I read an article about the Feds possibly raising the interest rate and there were comments posted about how stocks were going to crash because all these major businesses were going to go under due to it and others praising this possible move as a great thing because it would allow people to begin receiving great interest rates at the banks which everyone deserves. Opinions are basically on opposite sides of the pendulum for this one. Neither one was correct. Major businesses are not going to crumble due to a slight rate in interest rates. Banks may or may not ever raise the interest rates in line with the increase by the Feds. Even if the banks do pay higher interest rates to the customers who are banking with them, I think we can be sure the interest rate hike for those borrowing from them will raise even more. This is just another example of people freaking out about things they really know nothing about.