Fed Chair Janet Yellen Warns Again on Richly Valued Stocks and Bonds; Warnings to Exonerate the Fed?

Bubbles have become so obvious for political authorities to just ignore them.

In the past, where the 2008 crisis have caught them blind, today many political agencies or institutions seemed to have learned from their mistakes: They wouldn’t want to take the blame for any untoward unintended consequences. So many of them have been constantly issuing warnings after warnings on financial asset risks…but in different formats. 

Some authorities still deny the existence of bubbles but instead have focused on ‘symptoms’ such as high valuations which they attribute to ‘yield chasing’ and selective leverage. They hardly seem to comprehend how high valuations have emerged from yield chasing as seen via the source of financing--credit, as well as, its simultaneous effects to the financial and production structure of the economy. 

This is unlike the Bank for International Settlements whom has a relatively firm grasp of the ongoing brazen misallocation of resources. The BIS had been followed by the IMF and the OECD and somewhat by ADB and the IIF. 

National central banks as Singapore’s MAS, Australia’s RBA India’s RBI and others, have in their own ways, admonished on brewing domestic imbalances. The Philippine BSP governor even joined this bandwagon last August and October but appears to have backtracked via a deafening sound of silence.

As I have been saying, most of such warnings possibly represent escape clauses, valves or hatchets aimed at exonerating them rather than to justify changes in policies. The other possible unstated objective could be to shift the burden of bubbles to the markets, rather than from their policies.

A splendid example would be US Federal Chairwoman Janet Yellen. Last night, Ms Yellen raised (again) the overvaluations hounding US stocks and bonds. Ms Yellen, ironically, hardly connects these to financial stability issues. 

Yet this marks her third irrational exuberance warnings (the first on July 2014 and in February 2015).

From Bloomberg: (bold mine)

Federal Reserve Chair Janet Yellen, surveying the financial landscape for signs of bubbles after more than six years of near-zero rates, warned that both stocks and bonds are richly valued.

“I would highlight that equity-market valuations at this point generally are quite high,” Yellen said in Washington on Wednesday in response to a question at a forum on finance. “Now, they’re not so high when you compare the returns on equities to the returns on safe assets like bonds, which are also very low, but there are potential dangers there.”

Yellen said bond yields “could see a sharp jump” when the Fed raises its benchmark interest rate. Most Fed officials predict that will happen this year for the first time since 2006…

Yellen said that after holding rates near zero since December 2008, the Fed must be on the lookout for threats to financial stability. She spoke in response to questions from International Monetary Fund Managing Director Christine Lagarde during a panel discussion at the “Finance & Society” conference sponsored by the Institute for New Economic Thinking.

She said she sees signs of “reach for yield” in the market for leveraged loans, and that bond yields could jump when the central bank raises its benchmark rate.

“Long-term interest rates are at very low levels,” Yellen said. “We could see a sharp jump in long-term rates” after liftoff.

“We saw this in the case of the taper tantrum in 2013, where there was a very sharp upward movement in rates,” she said in reference to the episode in the middle of that year, when then-Chairman Ben S. Bernanke suggested that the Fed could start tapering its bond purchases in the next few meetings.

Ms Yellen seems caught in a bind of logical contradictions. First, she ‘warned that both stocks and bonds are richly valued’. Next she says that the FED should respond by looking out for threats to financial stability. Then she says that a jump in bond yields could pose as potential dangers. She doesn’t see that both stocks and bonds, which are richly valued, are in reality threats to financial stability and potential dangers already staring at her and the FED's faces.

And her concerns over a liftoff means that richly valued stocks and bonds could unravel once the leverage that has pillared such imbalances reverse.

Why should an interest rate ‘liftoff’ pose as a potential problem to richly valued stocks and bonds if these have NOT been founded on the massive accrued leverage from low levels of interest rates? 

Besides, if financial markets have truly been sound then why the worry over a liftoff—which should really be very minimal 25 bps perhaps—at all?

Ms Yellen tries deliberately to blur the cause and effects, or have been oblivious to the process of how low interest rates drives debt financed yield chasing frenzy to engender rich valuations and severe market dislocations, or has been looking for an excuse or justification (by shifting the onus on the marketplace) NOT to have a ‘liftoff’.

But even with a dawdling fickle minded FED, the US Treasury markets seem to have already made up their minds: The 'liftoff' process seems to have already begun!

And the 'liftoff' has become a global phenomenon. Has the bond vigilantes returned?

Ms. Yellen and her team at the FED appears trapped and so these warnings?

By the way, even the US Treasury’s Office of Financial Research has recently warned of increasing symptoms of financial instability risks.

Not to worry. This time is different: stocks can only rise forever!