“Powell has talked a lot about the job market and that the cure must include all workers who want a job. And Yellen is a labor economist,” said Quincy Krosby, chief market strategist at Prudential Financial. “So it is possible that the Fed is too moderate and allows inflation to get hotter.”
Inflation is not a problem at the moment. Consumer prices have risen by less than 2% over the past 12 months, according to the Fed’s preferred measure of inflation, which looks at personal consumption expenditure.
But some concerns that can cause bubble formation. Stocks are near record highs and the housing market is red hot.
This is partly driven by a friendly monetary policy from the Fed and hopes for more stimulus from the forthcoming Biden administration.
Inflation is slowly creeping back?
“Official numbers don’t show the inflation that people see in their daily lives,” said Patrick Leary, chief market strategist and senior trader at Incapital.
“Most Americans spend a lot on housing, food, education and health,” he said. “They’re all going up in price. That doesn’t feel like deflation to me,”
And Krosby is concerned that the Fed will continue to step in to keep interest rates from hitting to keep the Wall Street party going.
“Investors need the bond market to function properly,” said Krosby. What if inflation does start to creep up higher? So what is the Fed willing to do? ”
Those concerns are fueling concerns that the stock market may continue to rise – then plummet once the Fed and Yellen begin to signal that the economy is strong enough to get rid of stimulus packages.
Taper Tantrum, Part 2?
And it wouldn’t be the first time.
Wall Street sparked a waning tantrum in 2013 when Fed Chairman Ben Bernanke began to withdraw from the bond buying program in the Great Recession, which was similarly implemented to keep interest rates low and stimulate the economy.
The hope this time around is that Powell has learned from the past, with some experts predicting he won’t do anything anytime soon or drastically.
“We continue to view the Fed, along with every other developed market central bank, as highly accommodative,” Marvin Loh, senior global macro strategist at State Street, said in a report.
“To avoid a diminishing tantrum, Chair Powell has hinted that a change in the pace of asset purchases will be well communicated,” he added.
Others argue that it is unwise to bet against current market momentum. As long as the Fed and the Treasury Department are in favor of more stimulus, the natural direction for equities is to keep going up. Younger traders – the so-called Robinhood crowd – are unlikely to hit the market just yet.
“Professionals and a few others probably understand that this market is partially unrelated to reality, but the majority disagree. This creates a strange dynamic,” Sebastien Galy, macro strategist at Nordea Asset Management, said in a report Wednesday. “What we can conclude is that the market may remain irrational for longer than you can remain solvent.”
But it may not be that simple. The major concern is that as stocks continue to rise, inflationary pressures will increase as people gain confidence in the economy.
Ultimately, the Fed could be forced to act faster than it wanted to to cool things down.
“Inflation can be transitory until it lingers. If you can charge more for goods and services and still see consumer demand, why lower the price? That’s just logic,” said Leary of Incapital. “The Fed can tolerate inflation rising, but not exploding higher.”