Quicks Thoughts on the Market and the Fed

Thomas Warns*



A very peculiar thing happened today. For the past few business days, U.S. stocks have been dropping, as worries about Ebola, combined with warnings about another recession in Europe and larger geopolitical fears, turned many investors bearish. Despite all these factors weighing on the minds of investors, the Dow Jones Industrial Average, NASDAQ, and S&P 500 all paradoxically increased sharply today. How could this be?

Well, in effect it was precisely because of all this negative news that the markets shot up. All of the fears of a global downturn led the Federal Reserve to announce today that it would not begin to raise benchmark interest rates yet, as that might imperil the economy. In this perverse way, bad economic news is welcomed by Wall Street, while good economic news might actually cause the markets to decline, if the Fed were to then believe it could then raise the federal funds rate. This seems to raise an important question: are the bullish markets actually reflecting a better economy, or are some backwards incentives at play here? Of course, one could answer that perhaps the decline over the last few days priced in fears that the Fed would raise rates, and now the markets are rebounding with the knowledge that they won't. But shouldn't a healthy market react to changes in global economic conditions, rather than the tinkering of a government interest rate by a few bureaucrats? Every Federal Reserve session is closely followed, and the minutes released can spark significant changes in the market. Shouldn't any government intervention in the economy aim to stabilize, not destabilize?

The solution might be to permanently keep the Fed's rates low; unfortunately, that is not really an option. For one, the low interest rates will eventually need to be raised in order to fend off inflation when it starts to grow too high. In addition, low interest rates may be encouraging too much risky lending and borrowing, which, if memory serves, does not always end well for the economy. Is the Federal Reserve essentially blowing a larger and larger bubble by keeping rates artificially low, which in turn pushes the stock market higher and higher on risky loans while underlying indicators of poor financial health are ignored? Only time will tell.

* Thomas Warns is a J.D. Candidate in the Class of 2015 at New York University, and the Editor-in-Chief for the N.Y.U. Journal of Law & Liberty.