Did the Stock Market Tell the Fed to Cut Rates?

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The answer may be yes and no.

The stock market is just responding to changes in the economic environment, which currently suggest the economic outlook is dimming.

The Coronavirus is keeping manufacturing plants shut down and consumers from going out of their homes, hurting economic growth and possibly hurting inflation.

So when stock prices fall, they’re reflecting lowered expected revenue and earnings from corporations.

Stock investors would like to see some stimulus added to the economy — monetary stimulus in the U.S. 

That’s number one.

Secondly, with stock prices falling, investors are saying they’re not willing to pay a high price to own companies’ equity, as they’re comparing stock returns to the yield they can get on safe bonds, like treasuries.

This causes a rush of money into treasuries, bringing the price of those higher. When prices rise, yields fall, as they have of late.

Bond yields fall and so banks can only lend at the lower interest rates. That’s the economy saying, the bond market saying, the stock market saying, lower rates are warranted for the economy to keep growing and for the value of companies’ equity to grow.

The Federal Reserve, which influences interest rates, listens to the market, and certainly did so in 2018 after it had raised rates too aggressively for the market’s liking.

But while markets are generally efficient, they’re not always right. The Fed just needs to watch the economy, and the bank is armed with economists trained to do so.

Markets are just assessing perceived future outcomes and pricing what they’re willing to pay for those outcomes. Prices reflect the perception of economic outcomes.

Now to see what the Fed is ultimately focused on, watch the quick video above. 

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