Does the Fed want stocks to rise or fall?

It often appears that no matter what the Federal Reserve does, its actions are destined to draw the ire of market participants.

Now, it appears that what it doesn’t do is at least as likely to ruffle feathers.

The recently released minutes to the Fed’s September meeting showed the committee fretting about the sharp drop stocks had suffered over the past month. It was mentioned as a negative in the economic outlook prepared by the committee staff, and factored into the policymakers’ economic outlook.

Those factors, along with several others, are widely seen as keeping the central bank from meting out its first rate hike in almost a decade.

“The growing debacle surrounding the election of a new Republican House Speaker and the potential crisis if Congress doesn’t raise the debt ceiling within the next month are additional risks that have sprung up in the past couple of weeks,” Capital Economics said in a research note last week. “Accordingly, we now expect the Fed to wait until early 2016 before beginning to raise interest rates.”

However, the Fed’s emphasis on downside risks is injecting a degree of uncertainty—and volatility—into markets, a factor not lost on global policymakers that are calling on the Fed to end its handwringing and begin the tightening cycle.

“In the United States, equity prices fall, on balance, amid significant volatility, and risk spreads for businesses widened,” the Fed minutes note. “Many participants judged that the effects of these developments on domestic economic activity were likely to be small, but they acknowledged the risk that they might restrain U.S. economic growth somewhat.”

The minutes go on to state that the stock drop was not a primary factor behind the Fed’s widely anticipated decision to keep its interest rate target on hold.

However, it added that “participants indicated that they did not see the changes in asset prices during the inter-meeting period as bearing significantly on their policy choice except insofar as they affected the outlook for achieving the Committee’s macroeconomic objectives and the risks associated with that outlook.”

Read More The Fed is showing that the market matters most

Still, it was clearly a factor lurking in the background, to the extent that the market drop has weighed on inflation expectations.

What does the Fed want?

Although the central bank has played down its impact on the market, the irony is that the Fed has itself complained about high stock prices.

In May, Fed chair Janet Yellen chose to “highlight that equity market valuations at this point generally are quite high,” adding that “there are potential dangers there”—particularly because valuations may be high partially as a result of low bond yields, and yields could spike when the Fed raises rates.

A year earlier, in July of 2014, Yellen said valuations were generally in line with historical norms, but “some things may be on the high side, and there may be some pockets where we see valuations becoming very stretched.” At the time, Yellen appeared to single out social media and biotech stocks.

Lo and behold, the industry group that contains biotech names has been the worst-performing group in the S&P 500 over the past three months, falling nearly 9 percent during that time.

Cramer: Biotech infecting the market—Will it stop?

That might suggest that the Fed should cheer, rather than bemoan, the recent volatility.

To its credit, the Fed seems to be aware of this inherent conflict. Some members of the FOMC apparently “commented that the recent decline in equity prices needs to be viewed in the context of overall valuation levels, which they saw as relatively high, and a couple noted that volatility had begun to subside,” according to the Fed’s minutes.

Yet an argument can be made that what the Fed was really worried about is not the level of equity prices, but their volatility. The minutes use that word six times, even delving into the world of derivatives, in recording that “one-month-ahead options-implied volatility on the S&P 500 Index reached levels last seen in 2011.”

The Fed clearly considers rising market volatility to be a mark of deteriorating financial conditions, and hence an economic risk factor. Since it might weigh on the Fed’s near-term economic expectations, it would also serve the function of delaying a rate hike even more.

All of this suggests that the Fed may not be cheerleading higher stock prices. However, the context of assuaging jittery investors is key.

If stock prices fell while volatility declined—which would admittedly be a unusual turn of events—it might actually decrease the perceived risks of raising rates. That could make the Fed more willing to step away from stimulative policies, and from attempts to handicap the market’s gains.

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