The tech-heavy NASDAQ 100 Index gained nearly 4% from its morning trough after Federal Reserve Chairman Jerome Powell told a Senate Committee that the US economy remained weak and that the Fed would continue its bond-buying binge.
Tech stocks in Tuesday’s session moved in near-perfect contrary motion to the yield on 5-year Treasury Inflation Protected Securities, the so-called “real yield.” Market chatter during the past week centered on supposedly rising inflation and eventual “tapering” of monetary ease by the US central bank, and traders positioned for higher bond yields and lower stock prices before the Fed chair’s testimony. But Powell declared that inflation wasn’t a worry, that the economic recovery was “uneven and far from complete,” and that the Fed would continue to buy $80 billion worth of securities a month. Stocks bounced back.
A popular ETF of Chinese tech stocks, KWEB, fell by nearly 6% during the first 15 minutes of trading before recovery to end virtually unchanged for the day.
“Premature Panic About the Fed and Inflation” was the title of my February 18 analysis in Asia Times. Neither the price data reported by the US Bureau of Labor Statistics nor the forward-looking inflation expectations embedded in bond prices pointed to a new inflation cycle, I argued. The Fed chairman made the same argument, and stock investors decided that they had in fact panicked prematurely.
The market fears a return to the pre-COVID regime of late 2019, when real yields rose with commodity prices in anticipation of faster growth.
Investors fear a return to pre-COVID circumstances. Before the COVID crisis, as shown in the circled segment of the chart on the upper right, the relationship between commodity prices and real yields was positive (both responded to real growth prospects). After the COVID pandemic began, the relationship turned negative, as shown in the circled area of the chart on the lower right. The Federal Reserve bought $3 trillion of securities and reduced its overnight rate to zero. Real yields fell even while commodity prices rose, because of the Fed’s “quantitative easing,” that is, multi-trillion-dollar securities purchases.
Inflation expectations have risen, but they have only risen along with commodity prices (and a tad to account for supply disruptions. The Fed’s favorite measure of inflation expectations, the 5-year inflation rate five years forward, is shown in the chart below.
There is a straight line relationship between the 5-year inflation swap 5 years forward (on the vertical scale) and the S&P/Goldman Sachs Commodity Index. That relationship has remained in a straight line from January 2020 to the present; the only change has been an upshift in the line, by about 20 basis points (0.2 percentage points). That’s not enough to attract the Federal Reserve’s attention. The 20 basis point shift in the regression line between commodities prices and expected inflation reflects supply interruptions due to the pandemic.
There’s nothing to indicate that the US economy is running so hot that the Federal Reserve would have to tighten monetary policy to control inflation.
The most widely followed (and most predictive of future economic conditions) among the regional Federal Reserve economic gauges is the Philadelphia Federal Reserve’s. The new orders component of the index, the most forward-looking element in the survey, shows a sharp drop during the last two months.
Nothing in the present economy justifies another “taper tantrum,” the 2013 jump in Treasury yields and fall in stock prices that ensued upon the “tapering” of the Fed’s quantitative easing. Tech stocks are rich and valuations may be stupid, but the Fed is not going to be the entity that pops this bubble – not in any case for quite some time.