Yield Curve, the FED (BOE) & P/E's
Changes in short-term interest rates by the Fed (or the BOE), on their own, have minimal impact on stock market P/Es...unless the Fed is unsuccessful in controlling inflation or preventing deflation. Increases in short-term rates are intended to contain inflation, the driver of P/Es and long-term interest rates, at levels of price stability. Decreases in short-term rates, often to stimulate the economy, must be done in a way that does not cause inflation or foster inflation expectations.
The implication of an average yield curve spread of approximately 100 basis points (1%) is that the interest rate that relates to inflation expectations, the long-term rate, is likely to stay relatively low. When the spread exceeds 1%, the implication is a risk of potentially higher inflation and
lower P/Es. Spreads below 1% imply tighter monetary policy and efforts to control inflation risks (yet this also creates the risk of deflationary conditions and lower P/Es).
The spread refered to above applies to all points along the yield curve similar to a percentage band above and below the moving average.
