Financial History 139 (Fall 2021) - Page 15

Collection of the Museum of American Finance
Throng at the steps of the subtreasury building ( now Federal Hall ) across the street from the New York Stock Exchange , October 1929 .
yield curve , for bonds maturing over the span of 10 years or more that traditionally have not been controlled by the Fed ? Historically , the difference between the federal funds rate and the long end of the yield curve has signaled either inflationary times or recessions coming .
In March 2020 , the interest rate on a 30-year US Treasury bond bottomed at 1.27 %. By March 2021 , it had surpassed 2.4 %. It currently stands at 2.09 %. This peripatetic movement of the long end of the curve with a constant federal funds rate at the short end indicates the market is confused between inflation or deflation on the horizon . This market confusion is compounded by the Federal Reserve buying up government bonds through a process called quantitative easing ( QE ) to inject more money into the economy . Without the Fed purchasing billions of dollars in Treasury bonds each day , interest rates at the long end of the yield curve would be higher .
If the Fed terminated QE , we could hear the resulting crack of this leg of the stool . The Fed has stated that it will begin to “ taper ” ( i . e ., reduce the level of QE purchases ) as early as mid-November 2021 . Until then , with the Fed intervening on the long end and controlling the short end of the yield curve , however , the true stability of this leg of the stool is unknown .
Importantly , these record-low interest rates also affect the equity evaluations calculated above , which had suggested that P / E ratios above their historic averages indicate we might be nearing a bubble burst . If one were to adjust for recordlow interest rates using the earnings yield 3 — the inverse of the P / E ratio — one might discover that stock values are not as inflated as they initially appeared .
The difference is currently 3.89 %. For perspective , that spread had narrowed to zero at the peak of the housing bubble . This suggests that because of record-low interest rates , stock prices are not as inflated as they first appeared . Certainly , they are not as inflated , or in as much of a bubble as the bond market . There is a maxim on Wall Street among the pros : “ Don ’ t fight the Fed .” It seems as true today as it ever was .
4 . Public Participation
There has never been a financial bubble without the public getting into the market . The general public is the last party to begin participating in a bubble , and inevitably the last to get out — a phenomenon ( borrowing from accounting terminology ) of LILO , “ last in , last out .”
Today , easy-to-use trading apps like Robinhood with zero commissions lure retail investors to return to the stock market after exiting in droves after the
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