Here’s a real conundrum for ya: Who do you fight, the Tape or the Fed?
That’s my takeaway from an interesting WSJ discussion earlier this week: "As the Federal Reserve prepares to raise short-term interest rates again next week, officials there increasingly believe the bond market, which sets long-term rates, is diluting their efforts to tighten credit and contain inflation.
The result: The longer the bond market keeps long-term rates unusually low, the further the Fed is likely to raise the short-term rates it controls in an effort to keep the economy from overheating. Conversely, sharply higher bond yields would encourage the Fed to stop raising short-term rates."
Graphic courtesy of WSJ
I do not believe bonds to be overvalued, as the Chairman implied in a recent speech. Low yields are consistent with my expectations for modest economic growth next year –especially if the Fed keeps tightening.
Ultimately, I think the Bond market is more powerful than the Fed, at least over the long run. Thus, you watch the Fed (closely), but you don’t fight the tape.
Fed Sees Bond Market Hampering Its Steps to Keep Inflation in Check
The Wall Street Journal, August 3, 2005; Page A2