Friday's Market Minute: Markets Appreciate The FOMC's Balanced Wait And See Approach

After the Fed avoided a taper tantrum following the FOMC policy meeting Wednesday, we continue to witness another week where U.S. equities rally to fresh new highs and 10-year Treasury yields continue to meander around the 1.25 percent range. The committee’s message reflects a wide range of balanced views that clearly exist at the central bank. A reduction in the growth of the Fed’s balance sheet is eventually coming, but it won’t be rushed, which is a suitable balance markets continue to appreciate for the time being.

Even as equity markets continue to progress higher, sentiment seems to rapidly swing between extremes on any given day. One day the concern is runaway inflation, while the next, the prospect of falling long-term Treasury rates indicates tepid future GDP growth and disinflation. Below the surface, the less than expected GDP print this week showed that consumer spending had surged, while the negatives in the report were from inventory drawdowns attributed to supply shortages. Given how strong current demand has been, factory activity will most likely play catch up over the coming quarters.

Initial jobless claims remain elevated above pre-pandemic levels, which also suggests the economy is still far from achieving full employment in the labor market. On the surface, weaker than expected economic data are a positive development for both bond and stock investors alike, which confirms the Fed’s dovish approach to monetary policy. If the labor situation doesn’t dramatically improve over the next few jobless claims reports and next week’s nonfarm payroll report, a September taper will also seem unlikely. For the economy to reach the Fed’s goal of substantial progress in the labor market, the economy will need to have several back-to-back million-plus jobs created, which is also unlikely. With steadily improving labor and growth conditions, the FOMC has time to better understand the impact the current wave of infections will have, to see how the inflation picture evolves, and gather more data on the economic recovery that has shown such promising signs.

We must keep in mind that traditional monetary responses to rising inflation will be more muted than in past crises because technology, world trade, and financial markets are better developed and well equipped for efficient capital deployment to deal with shortages. As such, there is a low risk of an inflation-induced disorderly taper tantrum. Therefore, one could conclude that as the evolution of the growth narrative is stretched into the next year, this will have a positive effect for risk appetite.