A “Symmetric” Approach to Inflation Increases Volatility In Stocks

This article was originally published on Nadex.com.

Fed-speak is a language that dates back to Alan Greenspan the Chairman of the U.S. central bank from 1987 to 2006. Fed speak characterized Greenspan’s tendency to make long-winded statements with little substance. The purpose of Chairman Greenspan’s technique was to mask the meaning of the Fed’s intent to reduce the impact of central bank policy on markets across all asset classes.

Greenspan’s two successors at the helm of the Federal Reserve put their respective spins on Fed-speak as Ben Bernanke presided through the global financial crisis of 2008, and Janet Yellen navigated through the years that followed. Both used monetary policy as a stimulus tool with Bernanke introducing quantitative easing and a zero short-term rate environment, and Yellen at the helm during liftoff from zero percent rates and the action plan to reduce the central bank’s swollen balance sheet from the legacy of QE. In 2018, Jerome Powell took the reins from Janet Yellen as the central bank moved forward with its gradual program of tightening credit in response to an improving economic environment.

Central bankers must walk a fine line between providing stimulus to the economy while avoiding the potential for inflationary pressures that eat away at the value of money. Perhaps the most disastrous condition, stagflation, occurs when the economy contracts and prices move higher. Over his first months at the head of the Federal Reserve, Chairman Powell has moved away from Fed-speak offering a more explicit message to markets and the American people when it comes to the monetary policies of the central bank. While past Chairs spoke in language that appealed mostly to economists, Powell speaks with a populist style that is a sign of the times rather than the tradition established over the past three decades.

While the Fed has continued on its path of gradually increasing rates over the past months with Chair Powell at the head of the table, he has adopted a policy of a “symmetric” approach to the Fed’s two percent target rate for inflation. While the term itself is reminiscent of Fed speak, it means that the central bank is willing to allow the rate of inflation to rise above its target rate without immediately hiking short-term rates to encourage a continuation of economic growth.

While under past leadership at the Fed, a 2 percent inflation rate may have been a line in the sand when it comes to monetary policy, the “symmetric” approach is likely to leave a bit of a dovish stance for a more hawkish Fed over coming months, and perhaps years. The approach could encourage continued gains in the stock market as the Fed may not be willing to immediately choke growth with aggressive rate hikes as inflation data via the producer and consumer price index post gains. Additionally, the “symmetric” approach will do what Fed-speak did in that it will keep the markets guessing adding volatility to stock and other asset prices in the coming months and years. 

Source: CQG

As the weekly chart of the E-Mini S&P 500 futures index shows, volatility in equities has increased since Chairman Powell took over at the head of the Federal Reserve. The new era could be just the beginning of wider price variance in the stock market as well as in other assets which is good news for traders. Volatility creates opportunities for nimble traders and the “symmetric” approach to inflationary pressures could exacerbate price variance during Chairman Powell’s term which has just begun.

 

 

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