Stock Market Risk Is Higher Today Than It Was In The Dot Com Era

By >Tim Anderson | >@TJAnderson1

Wednesday was mostly about the Fed. Today started the same way. No one expected the Fed to hike rates at the March meeting—only Esther George cast a lone dissent in favor of a 0.25% hike. The Fed also revised its now infamous “dot plot” to project the likelihood of two rate hikes in 2016, whereas its former projection had called for four rate hikes.

The media jumped all over this as if the committee were significantly lowering its targets for tightening policy. In reality, all the Fed did was adjust its targets to get in line with market expectations. I doubt that a single Fed-centric economist out of 100 was calling for four rate hikes in 2016—and really, the Fed lowering its target for rate hikes should have been discounted by the market.

The reality is that the market reacted positively to the Fed statement, and after 2½ days of consolidating the breakout move from last Friday, markets moved higher in the last hour of the day. Now, they are showing a measure of follow-through. More significantly, stocks have easily shrugged off the early declines that stock index futures were showing for two to three hours before the cash market opened this morning.

The real reason for the risk-on rally

Markets are reacting positively because of comments and inferences from Yellen regarding inflation, as opposed to the Fed's rate hike revision. This overlooked fact didn’t garner many headlines from the media, but I think it gives great insight toward the attitude of how the FOMC will treat its inflation target of 2%.

Recent data on inflation has shown that we are well on the path toward hitting 2% annualized inflation that has been the Fed's stated target for years now. There is no doubt that plenty of data has shown less than robust economic growth, and Yellen was quite clear that they are willing to let inflation “overshoot” its inflation target of 2%. The Fed would allow this so that markets can gain confidence that the economy has enough steam behind it to maintain and build on its growth trajectory.

In plain English, the Fed is saying, “We’re going to do what we’ve always done and get so far behind the curve with our policy decisions that we have to overreact later.”  

The reality is that the stock market likes it, and with 10 trading days left in Q1, the sharp selloff we had the first six weeks of the year is quickly becoming a distant memory.

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