Hooked On Monetary Morphine, Large-Caps Are Beginning To Wish For Softer Data

Amidst continuation of aggressive accumulation of assets by the Federal Reserve and a trial balloon last week by Philadelphia Fed president of eventual tapering, large- and small-caps are going their separate ways – the former liking soft economic data and the latter disliking it.

Last Wednesday, Patrick Harker, the Philadelphia Fed president who becomes a voting FOMC member in 2023, speaking at a virtual event, said, “it may be time to at least think about thinking about tapering our $120 billion in monthly Treasury bond and mortgage-backed securities purchases.”

His mission was to put out feelers, not upset the markets. Hence, he immediately followed that up with “this is not something we are going to do suddenly, though.” No one wants a repeat of taper tantrum of 2013, when treasury yields shot up after the Fed announced it would, at some future date, reduce the pace of purchases of treasury bonds.

It remains to be seen if these sorts of trial balloons would be sufficient to prepare markets that are hooked on monetary morphine. There is immense liquidity in the system. Fed assets have gone vertical (Chart 1). In early March last year, the central bank held $4.24 trillion in assets, which have since grown to $7.94 trillion.

Right here and now, there is no risk of immediate tapering. The Fed is committed to its current pace of asset accumulation. But at some point, tapering will happen. The question is, will markets suffer from withdrawal symptoms?

Of late, investors have keenly focused on the inflation data. This, despite the fact that the Fed has made it clear its current policy is driven more by jobs than inflation, which it would not mind running hotter than its two percent objective for some time.

Inflation has picked up speed. In the 12 months to April, core CPI jumped three percent and core PCE 3.1 percent – the steepest year-over-year pace since January 1996 and July 1992, in that order (chart here).

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Disclaimer: This article is not intended to be, nor shall it be construed as investment advice. Neither the information nor any opinion expressed here constitutes an offer to buy or sell any ...

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