The Fed Doesn’t Care About Wall Street as Much as Wall Street Thinks

There’s something of a ritual performed each time Federal Reserve Chair Jerome Powell speaks to the press: A reporter asks Powell about financial conditions; he says they’ve tightened a lot; the Wall Street crowd snickers.

To them, the notion seems ludicrous. Notwithstanding the selloff the past few weeks, markets have rallied in start-and-stop spurts for four months, swelling equity valuations and making it easier for companies to raise cash in stock and bond markets. The implication is that the Fed is letting investors undermine its efforts to choke off the flow of money and tame inflation.

So why such wildly different conclusions?

The answer has a lot to do with the way each side defines financial conditions. Investors tend to look at indexes created by the financial community. Goldman Sachs Group and Bloomberg LP, the parent company of Bloomberg News, have popular ones. There’s a certain high-finance flair to them. The gap between corporate and Treasury bond rates plays a big role in each. So does the VIX, a measure of stock market volatility, in the Bloomberg gauge.

The Fed, it would appear, keeps it a lot simpler. Lael Brainard provided a window into policy makers’ thinking on the topic last month in her final speech as Fed vice chair. In unveiling evidence of tightening financial conditions, she cited, among other things, the two-fold surge in mortgage rates over the past year as well as the fact that short-term interest rates are now higher than inflation.