When Federal Reserve Chairwoman Janet Yellen hinted that it was "hard to tell" if the housing market was overheated, or the stock market in general, investors sold. The Fed hates bubbles. Investors look for clues that the Fed is ready to start popping.
But what investors worry about more is not whether housing and the stock market is overvalued; it's what they perceive the Fed to be thinking about higher wages. That's what matters now.
If the Fed says the rate of wage increases is not indicative of inflation then that would be mean wage increases are a sign of prosperity and faster economic growth. All good. But if the Fed hints that higher payroll and full employment is a sign of higher-than-expected inflation, then the market assume the Fed hikes faster.
"We've got a portfolio that turns over fairly actively. There are no big, long term thoughts. It's more medium term. And right now I'm more worried about a correction's impact on emerging markets over the next four to five months after this rally," says Jordi Visser, CIO for Weiss Multi-Strategy Advisers. "I expect the market to be reminded that there is more risk out there than they have priced in."
Emerging markets got killed in 2013 during the so-called Taper Tantrum, when investors were betting on the Fed pulling back its support for bonds and mortgage backed securities crushed.
Valuation stuff is rather 'meh' for medium and short term investors. Only the value fund managers are worried about valuation.
If the Fed says there is an asset bubble -- in housing, in bonds, in stocks -- the market will sell. If investors believe the Fed is worried about higher wages leading to higher inflation, and therefore higher interest rates, you get a double-whammy hitting the S&P 500. Markets will re-price as a result.
From Tax Cuts To Central Banks
The tax cuts and regulation rollback story is over. We are on to central bank actions again.
The era of excess supply in the global economy might be over too, thinks Neil MacKinnon, an economist for VTB Capital in London. Shrinking excess capacity, driven by slower growth rates in China, might have lowered the ‘speed bumps’ for the major economies so that stronger demand translates into higher inflation.
Monthly PMIs continue to show elevated levels of economic activity and global growth is estimated to be at 4.5% currently.
"The era of deflation concerns and secular stagnation might now be giving way to what could be called ‘The Old Normal’," says MacKinnon, defining that as stronger growth leading to higher inflation.
The IMF raised its global GDP growth forecasts to 3.9% for this year and 2019. All the core economies are expanding. The Bank of England is expected to raise its GDP growth forecast this week, despite all the talk of Brexit sinking the U.K.
Here at home, the Atlanta Fed is forecasting real GDP growth of an emerging market-like 5.4% this quarter, double existing trend rates for the U.S. Plus, there is a fiscal stimulus of $150 billion coming in the form of corporate and individual tax cuts which might over-heat the economy.
This is why the market is down nearly 1,000 points since Thursday's intraday high.
Markets are currently pricing three hikes of 0.25 percentage points this year. The first one comes after the March 21 Fed meeting.
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