For What It's Worth: It appears to me that the market has already priced between one and two full rate hikes into the stock prices. First there was the terrible pounding that we took in April that basically killed the momentum we hoped the earning season would generate. I think that major downdraft priced 75 to 100 basis points upward movement in rates into share prices. The second downdraft (the one we just experienced last Friday and yesterday) would put another 50-75 basis points upward movement into share prices, and notably, during this one, the sector held strong (my own portfolio was fortunate by being overweighted in AMAT). Thus, it seems to me that both the early summer rate hike and at least one fall rate hike are already priced. Where do we go from here with rates?
Obviously, all predicting future events is vain and doomed to fail, and yet I think this understanding of the Fed is important. The key will be the connection between the level of economic activity and inflation. What makes Don's article extremely relevant about Moskow's observations is this: The Fed doesn't care that much about the level of economic activity per se, except as it's related to inflation. If increased economic activity leaves inflation alone, the Fed would be happy to enjoy the recovery along with everybody else. It will get concerned however, if inflation starts to tick up alongside the level of economic activity, and that is when it will start to apply the breaks by ratcheting up rates. Now, surely, the market will anticipate rate hikes on any information about the robustness of the recovery. However, such price downdrafts can be quickly reversed if inflation in fact stays low. The final caveat, however, is that the economy almost by definition cannot continue to grow without the eventuality of demand for goods and services outstripping supply, and when that happens, prices will increase and that's inflationary pressure by definition. That's the reason behind the market's knee-jerk reactions to any positive economic news.
Finally, we may be strangely fortunate in one regard. Energy prices have been steadily climbing. They are a key component in the core measures of inflation, the PPI and CPI and yet inflation seems to remain very much in check. If we get some assistance from the Saudi's now and energy prices plateau and retreat some, there may indeed be little to stimulate inflationary concerns and we may be out of the woods for a while. Just some thoughts. Jess. |
