The S&P 500 (INDEXSP: .INX) is up 90 points this morning in reaction to the announcement of changes in monetary policy from the Federal Reserve. That full data is here and the nub of the Fed’s announcement is that they’re going to take inflation risks seriously.
Macroeconomics is a most uncertain science but it’s the Fed that has to make the hard decisions upon it. What was worrying the market as a whole was that the Fed was fluffing it.
The Fed’s joint targets are maximal employment consistent with a 2% inflation rate. They use Core PCE as their measure of inflation, something that usually runs a little cooler than the CPI that most of us look at. However, inflation has been well above that target for many months now. Of course, there was going to be transitory inflation accompanying the end of lockdown for technical reasons – there had been deflation during lockdown so year-on-year comparisons just will have inflation. There are other passing causes, fuel prices and it’s just not going to be true that used cars are worth more than new forever.
However, how many months of transitory inflation does it take before it’s not transitory? This is what was worrying the markets, the S&P 500 being a good measure of the market opinion as a whole.
There being a certain joy here. Which is that if the Federal Reserve treats inflation as permanent then it will be transitory. The other side, that inflation will be permanent if it is treated as transitory is only maybe true. So, if the Fed changes policy to ameliorate inflation whether it is or isn’t transitory in theory then it will become so in reality. Fed actions will lower inflation either way.
The actual announcement from the Federal Reserve is that they’re going to taper stimulus. It’s important to note that this is different from what caused the “taper tantrum” a few years back. There the Fed was actually not replacing QE bonds as they matured. This means the stock of QE was declining, with significant upward pressure on interest rates as a result. Here the “taper” is that the Fed is going to reduce the rate at which it buys new QE bonds. So, rather than significant upward pressure on interest rates, we get a little less downward pressure upon them. Interest rates still move, of course, inflation is still being taken seriously and something done about it. It’s just milder action unlikely to produce that tantrum.
This is the news that has produced the bounce in the S&P 500. Inflation may still persist, this economic management is difficult. But that the Fed is determined to change policy to deal with it aids that macroeconomic picture. As the S&P 500 is the best stock market measure of that macroeconomic picture the S&P 500 benefits from the Fed clearly taking inflation seriously.
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Tim Worstall is a freelance writer specialising in economics and the financial markets.