One passage in particular caught their attention:
"A number of participants suggested that if the economy continued to make rapid progress toward the Committee's goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases."
Can you spot the pivotal piece of information? This obviously carefully worded message said, according to the Fed watchers, that the Fed might just step off the gas a bit sooner than expected.
It couldn't have been more subtly put, but it certainly didn't go unnoticed. A large number of financial websites quoted the very same passage. And, yes, the markets sold off that day, perhaps anxious after the previous week's CPI release showing a 12-month US inflation rate of 4.2 per cent.
The major worry, of course, is that rising inflationary pressures will force a perhaps premature tapering of quantitative easing measures and also, at some point, higher key rates.
All things considered, the markets were reassuringly composed in May. Stock prices and credit margins ended pretty much flat. But let's stop for a while and consider the importance of the market moving news this month. What if inflation moves even higher or takes longer than expected to normalise again?
Let's lift our gaze. With a sufficiently long-term perspective, stocks are, arguably, an inflation hedge. Most companies will be able to increase their prices in line with increased costs, meaning that with a general rise in prices, price hikes are passed on to consumers. Unless real interest rates appreciate, the stock market should be ok in the sufficiently long term.
Of course, in the meantime, capital flows will be sensitive to nominal rates. But if you agree that it shouldn't matter much ten years from now, what about nine? Or eight? If this sounds excessively long-term, please remember that we're in this for the long haul.
Now, what about fixed income? I'd say it depends critically on what kind of bonds you hold. Given fairly constant real rates, floating-rate notes – common in the Nordic corporate bond market – should be a good protection against rising nominal rates. If you only hold fixed-coupon bonds, however, you risk getting hammered if nominal rates rise more than, well, nominally, although careful management can reduce this risk considerably.
In my opinion, the global economy has changed so much in the past 50 years that a return to the inflation levels of the 1970's is extremely unlikely. Admittedly, much lower levels of inflation may cause market anxiety, whether or not this should be a real cause of concern. If so, it is likely to be triggered by minutes from another FOMC meeting.
These are typically held eight times a year, the next one in June and likely to be published some three weeks later, so you can prepare for some expected surprises.
Oh, so you wondered whether, perchance, the market impact of FOMC meetings has been the subject of academic research? You bet. The latest article was published on the SSRN network in June, just one day before comment was written.
I may add that most of this research focuses on days or weeks rather than decades.
Finn Øystein Bergh
Chief Economist & Strategist
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