Behind Every Record-Breaking Market Level Is the Fed’s Largesse

Each market milestone passed in 2020 is a reminder of the Federal Reserve’s extraordinary efforts to hold things aloft -- and a belief that it’ll continue.

Consider today’s markets landscape. The dollar is the weakest since April 2018, pegged back by Treasury yields below 1%. That’s great news for emerging markets, and dollar bond sales in Asia have now topped $400 billion for the first time ever. Global stocks are at record highs and copper is near a seven-year high. Even Bitcoin has hit new records. And there’s little denying that the Fed has had a lot to do with it.

The sweet spot for risk assets and the Fed may be one in which economies do well, but not too well -- strong enough to prop things up, but not so hot that inflation starts to take off. Strategists from firms like Morgan Stanley, Goldman Sachs Group Inc. and JPMorgan Chase & Co. expect markets generally to do well into 2021 as Covid-19 vaccines become available and the world economy continues to recover.

Many assets have done well in 2020 as the Fed pumps in stimulus

With prices already so stretched, it could all come crashing down if the economy becomes so hot that inflation takes off and the Fed starts to discuss taking its foot off the gas -- or even raising rates.

For now, though, many strategists seem to be comfortable with the way things are going, sticking with Fed Chairman Jerome Powell’s assertion from June that “we’re not even thinking about thinking about” raising rates. The consensus among strategists is more stimulus, rather than less, and overnight index swaps aren’t pricing a Fed hike until late 2023.

“We believe the Fed is quietly monitoring the situation and will not allow the market to disrupt their lower-rates-for-longer approach,” said Anders Faergemann, a money manager at PineBridge Investments in London. “It would be too early to talk about or position for a taper tantrum.”

The Fed factor is rarely far from focus, especially if the economy starts roaring back as more people get vaccinated. It’s not impossible to imagine a sharp uptick in inflation as shoppers, who have been cooped up for months at home, start splurging on holidays and lavish celebrations of freedom.

In a note on Tuesday, Morgan Stanley economists led by Chetan Ahya listed domestic inflationary pressures and a “disruptive” change in Fed policy as among the top risks for emerging markets next year.

But that’s not the consensus view. Morgan Stanley is expecting a strong rebound in emerging markets powered by a weak dollar, low U.S. interest rates and the end of the pandemic.

“We can also be assured that the Fed will indeed be slow to normalize monetary policy,” wrote FX Strategist Kit Juckes of Societe Generale SA on Nov. 25. “They have promised to be, and probably won’t get enough inflation soon enough to make them change their minds.”

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