Inflation is the keyword and the policy framework to target it will determine whether we see more upside to risk assets in the months to come.
So far, we have only seen rising prices in asset classes such as stocks in particular, but throughout the past decade, the consumer price index has averaged around 1.5% so missing the Fed’s 2% inflation target. The FOMC’s dual mandate has been to maximise sustainable employment and keep prices stable and while they have been successful in the former (prior to the pandemic), they have failed miserably on consistently hitting their price target.
‘Average inflation targeting’ is the new formula expected to be endorsed by Powell today. It’s a policy framework that allows inflation to run above or below the 2% target, but given that inflation has been running below target for several years, the objective would be to allow price rises to overshoot for more extended periods before tightening policy.
However, the idea of allowing inflation to run above target for extended periods is hard to sell to politicians, so it will be interesting to see how Powell is likely to package the new policy framework.
The positive sentiment in US equities continued yesterday with the S&P 500 and Nasdaq hitting new record highs ahead of this week’s key risk event. It seems expectations may be too high as Powell will need to be overly dovish to meet these expectations. No one believes that he will disappoint the markets but given the scale of the latest rally in stocks, chances of a pullback are high before bulls resume their march higher.
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