10 Feb PERHAPS THE LARGEST QUESTION FACING THE MARKETS
Perhaps the largest question facing the markets is whether the commitments by the Federal Reserve and the Biden Administration to let the economy run hot will spark destabilizing inflation.
The answer to this question is pivotal in determining market direction.
As widely discussed, valuations are at best “stretched” as equity investors applaud increasing vaccination efforts, rising stimulus prospects and slowdown in COVID infections across the globe.
Inflation expectations are now the highest since 2013 and many regards the Fed’s strategy of permitting inflation and growth “to run above the prescribed speed limit for an undefined period of time or amount” is akin to walking on a razor blade.
To the best of my knowledge this strategy has never been attempted. I must write there are ample examples of lesser developed countries experimenting with massive deficit spending to increase economic activity, most of which ended in complete disasters.
There are only two ways to overcome massive debt…inflate or restructure. Restructuring is not an option given the US is the world’s only reserve currency. Almost everything is priced off the dollar and the US Treasury.
Yesterday Dallas Fed President Robert Kaplan stated “bouts of higher inflation that exceeds previously perceived limits will not be surprising but they are likely to be transitory.” Kaplan further stated the question might be “how persistent might these bouts be.”
Inflation is a two-part phenomenon; too much money chasing too few goods fearing higher prices tomorrow. It is part monetary and psychological.
Bonds trade on future inflationary expectations. What happens if these expectations become unanchored? Hopefully we do not find out with a $30 trillion-dollar deficit, a deficit that might be closer to $35 trillion in quick order, up from $20 trillion about 15 months ago.
Commenting in yesterday’s market activity, markets ended mixed, perhaps reflecting upon the infinite number possibilities of the most aggressive monetary and fiscal policy in history.
What will happen today? Will the CPI impact trading? FRB Chair Powell is scheduled to speak. Will his remarks impact trading? And then there is the 10-year Treasury auction. Will demand exceed expectations?
Last night the foreign markets were mixed. London was up 0.24%, Paris down 0.02% and Frankfurt down 0.04%. China was up 1.43%, Japan up 0.19% and Hang Seng up 1.91%.
The Dow should open nominally higher. Oil is broaching $60/barrel (WTI) and Brent is over $61. The dollar is lower. The 10-year is off 2/32 to yield 1.17%.