The Market Is Hot: Should the Fed Raise Rates Already?

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A financial boom, they say, is a good time to start preparing for a crisis. The Bank of International Settlements, the international counterpart to most central banks, has sounded out a similar alert for advanced economies like United States that have kept key interest rates at the zero bound for quite some time now.

“Financial markets are euphoric,” the BIS said in its annual report for 2013-2014. “Growth has picked up, but long term prospects are not that bright.”

The major equity indexes performed well last year, and asset prices rose much more than their realistic levels. The S&P 500 Index rose 20 percent since May 2013, but expected future earnings only grew 8 percent over the same period, BIS data show. The cyclically adjusted price-to-earnings ratio —  the ratio of an entity’s current share price compared to its per-share earnings — of the S&P 500, at 25, was higher than its average over the last 50 years.

This could be the result of growing appetite for risk and high yield among investors, triggered by low interest rates. The Federal Reserve has maintained the key funds rate — the rate at which banks borrow on an overnight basis — near zero since 2008, and the Fed is likely to continue to keep it near zero until mid-2015, when economic growth is expected to be back on its targeted trajectory and labor market conditions have improved sufficiently.

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