US Stock Market More Extreme Than In March

Just because the S&P 500 has regained almost all of its bear market losses and COVID-19 cases are starting to fall doesn’t mean we aren’t living in unprecedented times. There are some aspects of the current market that are even more extreme than this March. The most amazing situation in markets might be that the 10-year yield is at about 50 basis points which is near a record low in history, while the Fed is embarking on the most extreme path towards boosting inflation ever. If the Fed is successful, rates will spike. It’s amazing how much confidence stock traders have in the Fed to support equity prices and how little confidence bondholders have in the Fed to boost inflation and growth.

Last week, Powell stated the Fed will end its 1-year examination of policy communication and implementation “in the near future.” The Fed is still looking over the mistake it made to raise rates and shrink the balance sheet. The Fed would have been releasing its findings and updating policy anyway. With inflation lower than when it started this journey, it’s hard to overestimate the lengths the Fed will go to, to boost inflation. Powell stated the policy statement which should come in the next few weeks, will be “really codifying the way we’re already acting with our policies. To a large extent, we’re already doing the things that are in there.” This is enhanced forward guidance.

The Fed could specify the exact inflation rate it would need to see before raising rates. Evans of the Chicago Fed talked about not raising rates until inflation hits 2.5%. The bond market doesn’t believe the Fed. You can argue it’s completely unrealistic to even mention 2.5% inflation because of how far away the economy is from that. You can think of this like an unprofitable company saying it won’t issue new shares until it reaches an unrealistic goal on margins. It can be a critical mistake for the Fed to be so dovish if all the policy does is raise stock prices. That would create an even worse problem without generating higher inflation. As we mentioned, the stock market is confident in the Fed and the bond market isn’t. If they are both correct, this policy will only lead to trouble.

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