Easing up on the gas pedal

Low interest rates and the continued purchase of mortgage-backed securities played a key role in keeping credit markets fluid through the downturn and into the recovery, but there’s an argument to be made that the propping up of lending markets through monetary policy led to complacency among borrowers and lenders, and the time for an adjustment has come. It’s an argument worth considering more in light of recent market activity.

On Wednesday, the Federal Reserve issued a statement indicating that it would hold interest rates between 0 and 0.25 percent for now, but that the increasing resilience of the US economy may allow for raising interest rates at some point in the next two years. The market response translated to five year treasury yields spiking from 1.07 percent on Wednesday to 1.34 percent Friday. Public markets also fared poorly – the Dow Jones industrial average fell by an astounding 353.87 points Thursday, the largest single collapse since 2011, according to the Wall Street Journal. The S&P 500 suffered as well, falling 2.5 percent over the course of the day.

This type of reaction fails to take into account the fact that these eventual changes to monetary policy will be gradual and predicated on stronger inflation rates and lower unemployment rates, both of which are subject to fluctuation in an increasingly unpredictable global economy.

As it stands, the US unemployment rate is hovering somewhere around 7.6 percent. Even if that falls to 7.2 percent or 7.3 percent by the end of next year – as the Fed has predicted – it will likely take some time for it to reach a level where less quantitative easing could actually transpire. As such, the sudden spikes in treasury yields – which has a direct effect on the ability of private companies to issue new debt – seems unwarranted and somewhat rash.

“To use the analogy of driving an automobile, any slowing in the pace of purchases will be akin to letting up a bit on the gas pedal as the car picks up speed, not to beginning to apply the brakes,” Federal Reserve Chairman Ben Bernanke said in a press conference.

A measured response to say the least. Here’s hoping the market takes that into consideration moving forward.