Terry Trainor
Aug 28, 2017 · 2 min read

In the decade since the financial crisis the Fed and other central banks have, through their actions, convinced financial markets that central banks have very limited tolerance for risk asset sell-offs. Arguably the most influential action in sending that signal, QE, is coming to an end. Has the Fed still got the market’s back? How big a fall in the S&P 500 is the Fed willing to tolerate?

It seems to me that, if the Fed has a consistent risk management framework, there shouldn’t be any doubt about ‘once per quarter’ (note that the market is closer to once per year from here..). Unemployment continues to push through NAIRU estimates and, bar wage-based measures, the majority of indicators available to us point to labour market tightness; if the Fed believes their Phillips-Curve based models then they should get going before they find themselves way behind the curve. If their analysis said it was prudent to start hiking in 2015….

[Now, it’s become common to describe the Phillips Curve as ‘flat’ or ‘dead’, but how does the Fed operate an inflation targeting regime without a Phillips Curve framework? I find it hard to believe that they’re willing/able to abandon the core of the framework they’ve spent decades building just yet.]

…it would seem logical then to infer that the Fed’s framework for inflation targeting suggests that policy should be getting tighter, with little to quibble over. Add in that financial conditions have gotten looser since the Fed initially began tightening and that global growth is both better and more synchronised and it should be difficult for the Fed to hint at deviating from it’s current path?

That they allow the market narrative to evolve in any other way allows the market to continue thinking that the Fed’s got your back. They know that and, for whatever reason, they’re scared to give it up….. They’ve still got your back, but if wages start pick up in any meaningful way, they’re going to drop you like a hot potato.

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