Traders work on the floor of the New York Stock Exchange.
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The market is behaving as if it sees quite clearly how 2021 will turn out: Vaccines arrive, jets refill the skies, the economy revives, corporate profits snap higher, all while the Federal Reserve stays out of the way and maximally easy.
And in recent weeks, Wall Street has become quite persuasive in telling this tale. The most economically sensitive parts of the market are accelerating skyward, credit markets are drum tight, the tape is inured to bad Covid news and investors are ardently (too ardently?) throwing money at risky assets.
With all this pervasive perceived certainty, perhaps it’s a good time to consider a few underappreciated subplots that could emerge as central narratives to jostle investor assumptions as 2021 unfolds.
Will a booming recovery test the Fed’s dovish doctrine?
Fed officials could not be more clear about their determination to keep short-term rates at zero for years and to allow inflation to overshoot above their 2% target for some time to push the economy back toward full employment.
Chair Jerome Powell famously said he’s “not even thinking about thinking about” raising rates. In recent remarks to Congress he granted that if things break right there could be “upside risk” to growth for a while next year but it wouldn’t change his stance.
We can take him and his colleagues at his word. But consider the makings of a potentially hot-running economy, even for a couple of quarters, and ask whether the markets might insist on testing the Fed’s resolve.
Even without further fiscal support, consumers collectively are sitting on more than $1 trillion in “excess savings” over and above pre-Covid levels. The housing market is piping hot. S&P 500 companies have a record $2 trillion in cash and those with debt have refinanced at rock-bottom rates and extended maturities to record length.
A lot of this cash could spill into the economy in a hurry if normalcy returns and animal spirits percolate.
Already, market-implied inflation expectations are back to pre-Covid levels near 1.9%, so a hot streak for growth could nudge them toward levels where some market participants will begin to see a “mission accomplished” moment nearing for the Fed.
It would be a great “problem” to encounter for the real economy. But chances are, a market-induced tightening scare would be unfriendly to equity valuations in the short-term.
Will the release of pent-up demand help Main Street more than Wall Street?
That $1 trillion or so in extra cash in consumer bank accounts from unspent stimulus checks and untaken vacations since March are the potential energy for a spending revival fully anticipated by investors.
Yet during the pandemic, there has been a spending binge on “stuff” – cars, appliances, sporting goods, dog toys. It’s only the services economy – restaurants, gyms, hotels, casinos, elective…
Read More: Here are 3 under-the-radar market story lines that could surprise investors