Fed: Prices remain high relative to fundamentals even after April market turmoil

Fed: Prices remain high relative to fundamentals even after April market turmoil

Despite the recent market turmoil in April, prices in various sectors have continued to remain high relative to their fundamentals, according to recent Federal Reserve notes. This persistence of elevated prices, even after the market fluctuations, raises questions about the underlying economic conditions and the role of uncertainty in shaping market dynamics.

The Federal Reserve's analysis, published on April 24, 2025, highlights that since 2019, selected measures of uncertainty regarding economic and financial conditions, geopolitical risks, and policy outcomes have reached their highest levels in decades [1]. This elevated uncertainty has been particularly pronounced in economic and trade policy uncertainty (EPU and TPU, respectively). The report suggests that such high levels of uncertainty can have meaningful economic effects, influencing investment, consumption, and credit conditions.

The Federal Reserve's analysis identifies six key metrics capturing various uncertainties experienced over the past five years. These metrics include Real Economic Uncertainty (REU), Inflation Uncertainty, Economic Policy Uncertainty (EPU), Trade Policy Uncertainty (TPU), Geopolitical Risks (GPR), and Financial Uncertainty (proxied by the VIX). The report notes that these uncertainties can lead to delayed or reduced investment, more cautious consumer behavior, and tighter credit conditions [1].

The economic effects of uncertainty are not uniform across these metrics. For instance, Real Economic Uncertainty (REU) and Inflation Uncertainty have been associated with broader macroeconomic fundamentals, leading to a wait-and-see approach among firms. Economic Policy Uncertainty (EPU) and Trade Policy Uncertainty (TPU) can cause delays in capital allocation and global value chain investments, respectively. Geopolitical Risks (GPR) and Financial Uncertainty (VIX) can lead to capital flight, currency depreciation, and tighter credit conditions.

The Federal Reserve's analysis also indicates that these uncertainties can have feedback loops with economic activity. For example, business cycle downturns can amplify uncertainty about future growth, while uncertainty about trade policy decisions can negatively impact economic activity. The report finds that an increase in uncertainty is followed by a statistically significant drop in industrial production and investment, with the magnitude and duration of the drag varying across measures [1].

In the context of the recent market turmoil, the persistence of high prices relative to fundamentals may be a reflection of these underlying uncertainties. Firms and households may be adopting a wait-and-see approach, delaying large investments and purchases until the underlying conditions become clearer. Financial institutions may also be pulling back from making risky decisions, worsening credit conditions.

Investors and financial professionals should remain vigilant about these uncertainties and their potential impacts on economic activity and market dynamics. As the Federal Reserve continues to monitor these developments, it will be crucial to assess how these uncertainties evolve and how they shape economic policy and market conditions.

References:
[1] https://www.federalreserve.gov/econres/notes/feds-notes/costs-of-rising-uncertainty-20250424.html