Markets appear to have quickly shaken off last week's concerns over inflation and the Fed. The S&P 500 closed the week at another high, and treasury yields appear to have found their footing. With Powell's testimony in front of Congress, it has become clear that the Fed is not worried about runaway inflation. They are sticking to their guns in terms of inflation being a transitory phenomenon. Based on this testimony, The Fed could be hinting that they will be slow to back off their accommodative stance regardless of what the dot plot might say. This suggests that inflation certainly could run above 2% for a time, but that we are a long way off from 70s style inflation in the eyes of the Fed.
The easing of concerns over the past week has shown up at the sector level for equities. Energy and Financials have been particularly leveraged to the prospect of an overly aggressive Fed. The two sectors have settled right back into the 2021 rhythm after last week's brief pause. However, it is notable that the tech and other growth-oriented sectors held their ground. With both "value" and "growth" stocks working okay, this is perhaps a signal that inflation could settle into the healthy range over the long term. The Fed has been desperately trying to kick-start inflation for much of the last decade. We may be on the cusp of a more beneficial level of sustained price increases. Potentially, a level that would be good for a wide variety of stocks and particularly those in need of some pricing power. It is still too soon to tell how the inflation narrative will play out, but the anxiety does appear to have come down a notch.
Developments out of Washington are also helping to break down the wall of worry. President Biden announced this week that Democrats and Republicans have agreed in principle to a bipartisan infrastructure deal. To get progressives on board, Biden is proposing a separate multi-trillion-dollar reconciliation bill to cover the spending and tax increases left out of the bipartisan agreement. However, a multi-trillion-dollar deal is becoming a taller order with each passing day of the recovery. The Democratic party itself is far from unified in its approach to such a bill. Getting that big of a package through two narrowly divided chambers seems almost a non-starter. We believe the probability of corporate and individual tax increases is much lower today than just a few months ago. Markets certainly appreciate this. Taxes are far from off the table entirely, but they likely wouldn't have the same bite that markets feared a few months ago.
Preston May, CBE®
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