US Federal Reserve

Federal Reserve officials are finally waking up to the fact that there’s something wrong with their inflation models. It only took them five years.

As Bloomberg points out, the minutes from the Fed’s July policy meeting, released yesterday, included a debate about whether the models that help the central bank set its inflation target are no longer functioning properly.

“Federal Reserve officials are looking under the hood of their most basic inflation models and starting to ask if something is wrong.

 

There were two explicit warnings about stock market valuations in the latest Fed Minutes: first, the Fed warned that "vulnerabilities associated with asset valuation pressures had edged up from notable to elevated, as asset prices remained high or climbed further, risk spreads narrowed, and expected and actual volatility remained muted in a range of financial markets." Then, in an odd admission, the Fed said that "recent rises in equity prices might be part of a broad-based adjustment of asset prices to changes in longer-term financial conditions, importantly including a lo

The Fed confirmed yesterday that stocks are in a bubble.

Lost amidst the usual Fed-speak about inflation and other items were the following nuggets.

1)   “Equities” (read: stocks) were the primary reason the Fed discussed financial stability risks.

2)   The Fed raised its assessment of financial stability from “notable” to “elevated.”

3)   The Fed discussed “stock valuations.”

This is simply incredible. Remember, we're talking about the Fed here... a group of people who go above and beyond to ignore risks in order to maintain the status quo.

The initial reactions wre modest but directionally 'correct' given the dovish bias to the Fed Minutes - stocks are up, bonds are up (lower in yield), and the dollar is down. But then traders read the warnings that due to excessively easy financial conditions, "a tighter monetary policy than otherwise was warranted", something Goldman has been warning about for months, and stocks sank.

To be sure, there were 3 very dovish quotes:

There are two, also known as non-GAAP four, things to look forward to in today's FOMC Minutes: inflation, and balance sheet, balance sheet, balance sheet.