In the land of textbook economics, a central bank takes away the proverbial punchbowl when the party threatens to spin out of control. The removal convinces the partiers to cool their jets. In time, the central bank rewards everyone by returning the punchbowl, thereby planting the seeds to launch a cycle anew.
Nothing’s quite so simple in 2006. In fact, much of what professors like to teach in economics 101 is up for debate. Take the punchbowl, everybody’s favorite central-banking metaphor for easy money. This basin of liquidity injection was delivered in earnest a few years back. Predictably, the presence of cash sloshing around the system ignited bull markets far and wide. Evidence can be found everywhere, with the repercussions continuing to the present. It’s hard not to find an asset class that’s not running skyward these days. As a sampling, here’s a slice of what’s unfolded so far in 2006, through yesterday:
Large-Cap Stocks: +5.24% (S&P 500)
Small-Cap Stocks: + 14.68% (Russell 2000)
REITs: 10.03% (Morgan Stanley REIT)
Commodities: +8.17% (Oppenheimer Real Asset Fund)
10-year Treasury: +1.12% (10 Year Constant Maturity Treasury)
Junk bonds: +2.98% (ML US High Yield Master II Index)
The Federal Reserve is of course currently engaged in a gentle effort to remove the punchbowl with minimal fuss. In fact, one might argue that the Fed has been attempting to elevate interest rates but without affecting investor perceptions, which is a bit like trying to trying to discipline Rover and hope that he still retains his old habits. But even the central bank’s subtle effort may be nearing an end, if yesterday’s release of minutes from the Fed’s March 27-28 FOMC meeting are an indication. “Most members thought that the end of the tightening process was likely to be near…” the minutes advised.
San Francisco Federal Reserve president Janet Yellen brought the thinking of the March minutes into the here and now in a speech yesterday by voicing concerns of “the policy tightening going too far,” via TheStreet.com.