Stock Analysis & Ideas

Wall Street Shakes Off Inflation Fears, What’s Next?

Wall Street shook off inflation fears last week, staging a rally on Friday that erased most of the losses early in the week. Nonetheless, all major equity averages finished the week with slight losses, ending a five-week win streak. Meanwhile, the closely followed 10-year U.S. Treasury bond yields ended the week at 1.57%, up from 1.47% at the beginning of the week.

Investors Begin to Question the Fed’s Inflation Theory

Investors in equities and fixed income securities have been growing anxious about the persistently high inflation levels. New evidence contradicts the Fed’s theory that inflation is just a temporary phenomenon due to market frictions, as it tries to adjust to the post-pandemic regime.

For instance, early in the week, a couple of inflation statistics released by the U.S. Bureau of Labor Statistics showed that inflation is running at an annual rate of 6%, three times the Federal Reserve’s target.

Meanwhile, an index of inflation expectations released by the University of Michigan came in at 4.9%, indicating that inflation is beginning to impact the decisions of households to buy goods and negotiate work contracts.

Inflation is already a significant factor in labor negotiations, as in the case of Deere & Co (DE) and the striking UAE workers. That’s worrying economists because it could set the economy up for a 1970s style cost-push, demand-pull inflation spiral.

Fed May Be Behind the Curve

The persistence of inflation at a time when monetary policy remains accommodative has raised concerns on Wall Street that the Fed is behind the curve, meaning that it is too slow to address the inflation problem. Thus, Treasury bond yields spiked, with the 10-year U.S. Treasury bond yield reaching 1.70% in the previous week.

What’s Next?

With earnings season ending, the state of the U.S. economy, along with fiscal and monetary policy, will be on Wall Street’s radar in the weeks to come. For instance, next week, Wall Street will get the chance to find out how the nation’s retailers fared in October.

They will also receive an update about industrial production and capacity utilization, two numbers closely followed by the Federal Reserve as it sets its monetary policy. Any surprises could take Wall Street on a wild ride.

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