Fed coming late to tightening party

Yesterday’s Fed policy announcement was certainly the focus of attention, and monetary policy has been driving headlines and market action for much of the year. However, our view is that fiscal policy is likely the bigger policy force in the economy nowadays, and fiscal tightening started some time ago.

Volatility returns as investors adjust to policy outlook

Equities, and asset prices in general, have seen a return of volatility during January, following over a year of very subdued volatility and strong returns. Why, especially in a historically favorable seasonal period? In our view, markets are adjusting to the indications of moderately tighter monetary and fiscal policy following a period of extraordinary support from both US macro policy drivers. Investors are debating whether policy makers will be able to reduce stimulus and inflation pressures without provoking excessive economic weakness, and this debate is showing up as volatility in markets.

Macro uncertainty is provoking volatility

Fed dodging another taper tantrum

The primary news from the Fed meeting yesterday was to clarify the likely timing of reducing and then ending the current QE (quantitative easing, or bond buying) program. Fed Chair Powell indicated that (barring any big surprises) the tapering would begin at the next FOMC (Federal Open Market Committee) meeting in early November and aim to be completed (bond buying would end) by the middle of 2022. This would be a somewhat quicker move to end QE than occurred previously, but markets seem prepared for this and thus unlikely to have a “taper tantrum” again.

In case you need a refresher course, it’s all stimulus these days

Much has been made about the divergence between the path of the US (and global) economy and that of the stock and corporate bond markets. Even while economic and earnings growth is historically weak and remains under severe pressure from a rapidly spreading virus, major stock market indices have rallied and are at or near all-time highs. Market valuations based on forecasted earnings over the next 12 months have clearly risen sharply.