With their resilience and refreshed appetite for risk, financial markets are daring the Fed to boost interest rates again.
The stock market is higher, credit conditions firmer and volatility tamer than when the Federal Reserve first nudged short-term rates above zero last December. And markets have absorbed the shocks of Chinese capital flight, violent oil liquidation and Brexit-vote panic rather nicely.
If those market disturbances were crucial factors in backing Fed Chair Janet Yellen away from a rough plan to tighten up to four times this year, then is the firmer footing now an implicit invitation by the capital markets to get on with it?
Here's a quick run-through of the market field position today compared to the day before the Fed cinched the federal funds rate up to a range of 0.25 percent to 0.50 percent in December, and to mid-September 2015 – when the Fed passed on a hike but many felt it should have pulled the trigger:
-The S&P 500 is at 2179, nearly 10 percent higher than both September and December of last year. The index trades at 17-times the next 12 months' forecast corporate earnings, up from around 16-times late last year, which shows either greater confidence in a return to profit growth, lower interest rates and/or a higher appetite for risk.
S&P 500, 1 yr.
-The market for riskier corporate bonds is looking flush. The prevailing risk spread over Treasury yields on the Merrill Lynch High Yield index is now 5.12 percentage points, down from 6.98 when the Fed raised rates in December and 5.71 a year ago.
BOFA Merrill Lynch High Yield Option Adjusted Spread
Source: St. Louis Fed
-The CBOE S&P 500 Volatility Index, a gauge of investor anxiety as exhibited in prices for protection against a drop in stock indexes, closed near the low end of its long-term range at 12 on Friday. It was above 20 last December and September – which led many to note that the Fed had never tightened with a VIX at or above 20.
CBOE Volatility Index, 1 yr.
-The U.S. Dollar index is sitting around the middle of its 2016 range - about where it was a year ago and lower than in December. The Fed would prefer not to see the dollar surging as it moves rates higher, which could accelerate a dollar advance – in itself a sort of global financial tightening.
"But, hold on," you might say. "Aren't the markets in rally mode exactly because they don't expect or want the Fed to do anything? Didn't stocks rally on a slight shortfall in August job growth reported on Friday, meaning it made an imminent Fed rate boost less likely?"
It's become common to hear the cynical commentators warn that the Fed might "never" be able to hike because if Yellen signals this intention markets will throw another tantrum that will cause her to defer action, yet again.
For sure, an element of the markets' recovery to new highs this year has been the message that the Fed is no longer in a hurry, that it won't be dogmatic about hiking a particular number of times in a year, and that ultimately rates probably won't get back to what used to be "normal" levels. And it's true that if markets are daring Yellen to hike, sometimes a dare is made in hopes that it will be refused.
But it's not quite the Catch-22 that's suggested by those who want to sound wised-up and world-weary. In an economy growing in a slow and choppy way, displaying a vexing mix of early- and late-cycle messages, an honest weight-of-the-evidence approach could be mistaken for fickleness or pandering to investors.