According to the Wall Street Journal, although central bankers mainly referred to the rise in bond yields when worrying about market reactions to interest rate expectations, their real fear was what was happening to equities. After all, in the past, rising bond yields have been taken as signals that the economy was recovering as long as they were accompanied by stable or rising equity prices.
"But this official sensitivity to equity prices is a worry, especially given that on at least two long-term valuation metrics, equities are seriously overpriced. The cyclically adjusted price-to-equity ratio and the replacement cost measure (the so-called Tobin-Q) suggest fair value on U.S. shares is a third or more below where indexes are currently trading. Even former Bank of England Governor Mervyn King warned earlier this year that equity markets had got ahead of themselves.
For central bankers, equity markets are doubly important. They are a leading indicator of the economy’s prospects and they are also a driver of those prospects through wealth effects: as people feel richer they spend more, giving the economy upward momentum".
