The Real Risk That the Fed Misinterprets Bond Yields

At the end of March, New York Federal Reserve President William Dudley gave a speech on the interaction between financial conditions and monetary policy. When he discusses this topic, I always fear he is laying out a road map to the next recession.

Sure, this is a complex issue. As Dudley notes, financial conditions can move counter to expectations in response to monetary policy. Yet I am concerned that he loses sight of some broader lessons of the past few cycles. Two stand out in particular. First, be cautious in interpreting a weak response of long rates to policy tightening as sign of loosening financial conditions. And second, if the Fed waits for equity markets to crash before reversing course, the central bank has almost certainly waited too long.