Yellen Fed Ramps Up Attention Over ‘Somewhat Rich’ Asset Prices

  • Stocks drop after Yellen calls attention to elevated prices
  • Fischer says equities don’t simply reflect economic outlook

Federal Reserve Chair Janet Yellen comments on current asset valuations and the future path of Fed policy with former World Bank economist Lord Nicholas Stern at the British Academy in London. (Source: Bloomberg)

It’s not an alarm bell, but Federal Reserve officials are suddenly talking more about rising asset prices.

Fed Chair Janet Yellen, Vice Chair Stanley Fischer and San Francisco Fed President John Williams on Tuesday all acknowledged that valuations in equity and other asset markets had risen noticeably in recent weeks.

“Financial arguments are starting to take more life,” said Stephen Stanley, chief economist at Amherst Pierpont Securities. “While you will never hear the Fed say they have lifted rates because of this, it is certainly weighing on the decision calculus in a way it wasn’t six or nine months ago.”

The debate over U.S. monetary policy has been fixated for months on whether policy makers should take their signal from falling unemployment, which has boosted the case for rate hikes, or sluggish inflation, which has counseled patience. Rising asset prices could introduce the element of financial stability into the mix, strengthening the argument to keep tightening policy.

Despite raising rates three times in the last seven months, borrowing costs remain near historic lows. Critics have long worried the Fed’s easy-money policy could lead to financial bubbles, though none have yet materialized.

The S&P 500 Index of U.S. stocks hit an all-time high on June 19. Commercial real-estate valuations relative to operating income have reached historic highs, and bond yields have remained near historic lows.

U.S. equities fell the most in six weeks on Tuesday after Yellen, answering audience questions at an event in London, described asset valuations as “somewhat rich if you use some traditional metrics like price earnings ratios.”

That followed remarks by Fischer earlier on Tuesday, who said increased valuations may reflect greater risk-taking as well as stronger growth prospects.

Brighter Outlook

“The general rise in valuation pressures may be partly explained by a generally brighter economic outlook, but there are signs that risk appetite increased as well,” Fischer said. “So far, the evidently high risk appetite has not lead to increased leverage across the financial system, but close monitoring is warranted.”

“You are seeing a little bit of a concern about asset prices,” said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York. “Concern might be a strong word, but they are taking note of it.”

In an interview with Australian Broadcasting Corporation television, the San Francisco Fed’s Williams said “the stock market still seems to be running very much on fumes.”

Fed projections call for one more rate increase this year. Fed officials have said they intend to begin trimming the central bank’s $4.5 trillion balance sheet this year.

Mickey Levy, chief economist for the U.S. and Asia at Berenberg Capital Markets in New York, viewed the Fed comments as another reason to believe policy makers will continue tightening policy this year along the path they’ve already set out.

“An investor should take away that the Fed is going to raise rates in line with their projections, and it’s going to gradually unwind its balance sheet,” he said.

— With assistance by Lucy Meakin, Jill Ward, and Matthew Boesler

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