What the Change in U.S. Monetary Policy Means For Your Stocks

US Monetary Policy

In the past few days, a new COVID-19 panic has gripped the stock market. The fear of new restrictions, which could once again severely affect the economy, weighed on prices.

Yesterday, a new worry was added: the tightening of monetary policy at the absolute worst time. Inflation has been rising steadily for more than a year. In the meantime, it has reached proportions that we haven’t seen in 50 years.

The Fed is Waking Up: Inflation Not Just “Transitory” After All

Nevertheless, we have always heard the same spiel from the central banks actually tasked with monetary stability and the associated mass media: this is only temporary (or “transitory,” to use the Fed’s exact words), it’s not so bad, it will soon return to normal.

Like hell it will. It has gotten worse and worse. And there’s no end in sight at all. And that now seems to have dawned on the Fed as well. Chairman Jerome Powell made a remarkable turnaround yesterday before the U.S. Banking Committee.

For the first time, Powell clearly moved away from the description of high inflation as temporary, saying that it was “time to retire the word transitory” to describe the current inflation.

And Powell didn’t just want to talk semantics, either. He hinted that the Fed could reduce its bond purchases more quickly than previously planned. He said it would be appropriate to talk about accelerating the so-called “tapering” at the next meeting of the Federal Open Market Committee on December 14 and 15, and perhaps concluding it “a few months” earlier than previously planned.

That would bring the Fed’s bond purchases to zero before mid-2022. When that happens, bond rates will rise, and with them the interest that companies must pay on their debt (via corporate bonds). That should curb borrowing and thus inflation.

Powell warned that the new coronavirus variant Omicron (by now we are on the 15th letter of the Greek alphabet) could further fuel inflation because of possible supply-side constraints. Restrictions could disrupt production and thus drive prices (further) up. 

U.S. Central Bank Now Finally Wants to Fight Inflation

Powell said the Fed will use its policy toolkit to cool the price increases. Which amounts to higher interest rates on debt. What we are seeing here is a 180! The central bank does see the danger of new burdens for the economy. But it no longer wants to combat this with a further flood of liquidity, as it has done in the past. It sees the greater danger in rampant inflation.

Great! Finally, a leading Western central bank that gets it! The European Central Bank, meanwhile, has lost the plot. They’ll still believe in temporary inflation 20 years from now, when the rate is 30% and we’ll all be equally poor.

However, the U.S. central bank’s realization also comes a bit late. The world is likely to run into a serious downturn in the next year – with or without a new lockdown. Tightening monetary policy in this situation naturally has the effect of accelerating the downturn. 

Doing nothing would accelerate inflation. In this respect, it is now only a choice between plague and cholera that the central bank has made. Cholera? Good. Good luck then!

What the Change of Course in U.S. Monetary Policy Means For Your Stocks

This change of course in U.S. monetary policy undoubtedly also has an impact on the markets. The U.S. dollar is strengthening (conversely, the euro is falling) because (bond) interest rates in the U.S. are rising. A strong dollar often (though not always) has a dampening effect on the price of gold.

Rising interest rates, on the other hand, are good for stock prices, contrary to popular belief. However, this is only true if interest rates rise because the economy is humming. If, on the other hand, they are only rising because inflation is getting out of hand, and if we then also see a downturn (together this is then called “stagflation“), it becomes problematic for equities. That is the scenario we will see next year.

Dr. Gregor Bauer
Dr. Gregor Bauer
Dr. Gregor Bauer credits his trading success to combining fundamental aspects of a trade with expert technical analysis. A Certified Financial Technician from the International Federation of Technical Analysts (IFTA), he’s rated as one of Germany’s top 300 economic experts.
Dr. Gregor Bauer
Dr. Gregor Bauer
Dr. Gregor Bauer credits his trading success to combining fundamental aspects of a trade with expert technical analysis. A Certified Financial Technician from the International Federation of Technical Analysts (IFTA), he’s rated as one of Germany’s top 300 economic experts.

Related Articles