The Coming Change In Monetary Policy

Janet Yellen, the Chairman of the Federal Reserve, has been signaling to the financial markets that the Fed is going to raise rates towards the end of the year. If this happens, it will be the first time in nine years that the Fed has raised rates in the US. And it will be the end of an extraordinary period of near zero interest rates that resulted from the financial crisis of 2008. The near zero interest rate policy allowed banks and brokerage firms to replenish their balance sheets, work off their book of toxic assets, and regain their health. It also allowed the US economy to rebound from the effects of the financial crisis, it allowed homeowners to hold onto homes through difficult financial times, and it allowed businesses to borrow and raise capital at very attractive rates.

A side effect of this period of cheap money is that the tech sector, venture capital, and startups have enjoyed a valuation environment that has been extraordinarily friendly. I wrote about this in March of last year and said:

It is the combination of these two factors, which are really just one factor (cheap money/low rates), that is the root cause of the valuation environment we are in. And the answer to when/if it will end comes down to when/if the global economy starts growing more rapidly and sucking up the excess liquidity and policy makers start tightening up the easy money regime.

Yellen has also been signaling that the Fed does not plan to make rapid and large increases in rates. So the valuation environment in the tech and startup sector may not change quickly. But it will change. And so will the valuation environment in the stock market. This is because valuation multiples are inversely correlated to interest rates. When rates rise, valuation multiples fall.

So, I am going to watch the Fed’s moves and the market reaction with interest. This may have an impact on the venture capital market and startup valuations so it’s not something to ignore.