Fed policy makers wary of financial market valuations

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When a trio of Federal Reserve officials delivered remarks overnight, the state of US financial markets came in for a little bit of criticism.

When all was said and done, US equities sank the most in six weeks, yields on 10-year Treasuries rose and the US dollar weakened to the lowest level versus the euro in 10 months.

When all was said and done, US equities sank the most in six weeks, yields on 10-year Treasuries rose and the US dollar ... When all was said and done, US equities sank the most in six weeks, yields on 10-year Treasuries rose and the US dollar weakened to the lowest level versus the euro in 10 months. Photo: Richard Drew

Fed chair Janet Yellen said that asset valuations, by some measures “look high, but there’s no certainty about that“. Earlier, San Francisco Fed president John Williams said the stock market “seems to be running very much on fumes” and that he was “somewhat concerned about the complacency in the market.”

Fed vice-chair Stanley Fischer suggested that there had been a “notable uptick” in risk appetite that propelled valuation ratios to very elevated levels.

The price of “risky assets”, Fischer said, had increased in most major asset markets in recent months, including equities, which now stand in the top quintile of historical distributions.

“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 also said. “So far, the evidently high risk appetite has not lead to increased leverage across the financial system, but close monitoring is warranted.”

The Fed officials’ comments came amid a torrent of events that buffeted financial markets on Tuesday in the US, from an IMF cut to its US growth forecast, Google suffering the biggest ever EU antitrust fine, a fresh blow to the Republican agenda in Washington and a global cyberattack. Still, selling in US shares accelerated around 1.30pm New York time as Yellen delivered her assessment of the market since the central bank raised interest rates June 14.

“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 ought to depend on long-term interest rates,” Yellen said during a speech in London.

Investors are on guard for signs of a change in its economic outlook that could delay rate increases or when it will begin shrinking its $US4.5 trillion balance sheet. Yellen said the Fed’s plans for the balance sheet were “well understood” by financial markets. Officials have said they intend to begin allowing the portfolio to roll off this year.

In the end, Yellen made it pretty apparent that that her plans for continued monetary policy tightening haven’t shifted.

“We’ve made very clear that we think it will be appropriate to the attainment of our goals to raise interest rates very gradually,” Yellen said.

Financial shares advanced, but not enough to save the S&P 500 Index from its worst drop in six weeks. The CBOE Volatility Index jumped 12 per cent.

The S&P 500 lost 0.8 per cent to 2419.38 at 4pm in New York. That’s the lowest since May 31.

The Nasdaq 100 dropped 1.8 per cent, the most since a 2.4 per cent rout on June 9. The index is at its lowest level since May 19. Alphabet dropped 2.5 per cent after being hit with a record EU fine.

“Yellen is expressing confidence that banking is stronger, economic growth is relatively firm and there’s not going to be a crisis in our lifetime,” said Dennis Debusschere, Evercore ISI’s head of portfolio strategy and quant. “It’s sending a signal that they can continue on rising rates, despite the weaker inflation we’ve seen. That’s where the concern is in the market.”

http://www.watoday.com.au/business/markets/fed-policy-makers-wary-of-financial-market-valuations-20170627-gx002v

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