It’s the Fed, Not Omicron

The stock market about-faced yet again today after Federal Reserve Chair Powell changed his tone on inflation and monetary stimulus (see below). At the moment, the Dow is down 660 points, and the S&P 500 is down 1.9%. Declines are widespread among sectors and industry groups. Commodities are also broadly lower, including gold. WTI crude oil fell back to $66.50/barrel. The bond market is trading mostly higher. Some money is flowing in safe-haven Treasuries and high-grade corporates. The yield curve flattened a bit because short-term Treasury yields backed up while long-term yields fell. This type of move is typical when investors believe monetary tightening is upon us.

In congressional testimony Jerome Powell put the world on notice that the Fed will likely tighten monetary policy quicker than previously anticipated. “At this point the economy is very strong and inflationary pressures are high and it is therefore appropriate in my view to consider wrapping up the taper of our asset purchases, which we actually announced at the November meeting, perhaps a few months sooner. I expect we will discuss that at our upcoming meeting.” Back on November 3^rd Mr. Powell said he’d give investors an advance warning of such a move, and this is it. One of the reasons for a quicker pace of stimulus removal is that he no longer believes elevated inflation is temporary. The problem with both monetary stimulus (aimed at keeping interest rates low to encourage borrowing & spending) and fiscal stimulus (government spending to spur growth) is that they encourage and feed inflation. An economy that is already growing and generating its own attendant inflation doesn’t need stimulus. And, in fact, history tells us that this can be damaging to the economy. So my sense is that investors agree with Mr. Powell’s pivot. But, of course, any monetary policy shift brings with it stock & bond market volatility. And that’s what we’re seeing today.

As I’ve mentioned in previous posts, investors are on board with ending the Fed’s quantitative easing (QE) program. But they’re not comfortable with the added uncertainty about when and how fast the Fed will begin raising interest rates. Fed officials have said rate hikes will follow quickly on the heels of QE tapering. So based on today’s comments the rate hike timetable has also moved up by “a few months.” This is really why the stock market is down today.

Investors are getting the idea that Treasury Secretary (and former Fed Chair) Janet Yellen can no longer be heeded. Her position within the Biden Administration, rather than her education & experience, seems to be coloring her stated views. It was enough that she claimed Build Back Better would not add to federal budget deficits. But now she also says this massive stimulus package will actually lower deficits over the long run. She also said today that she believes the government is on a “sustainable debt path.” The current economic situation demands that the wheat be separated from the chaff and I’m guessing her commentary will be culled as chaff.