Comment by nostrademons | Hacker News Reader

Comment by nostrademons | Hacker News Reader

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I'd question all of the "stocks keep marching higher" and the "it's not irrational" and the "only way out of this mess is inflation" narratives.

Take a look at the S&P 500 vs. the equal-weight S&P 500 over the last 6 months:

https://finance.yahoo.com/quote/ES%3DF/

https://finance.yahoo.com/quote/RSP/

The equal-weight S&P 500 has been on a steady march downwards since it became apparent in August that the Iran war was not even close to over, and is now getting close to correction territory (7% down). This is exactly what you would expect given the news. It is the opposite of what you would expect from the inflation story, which would lift the earnings of everything in the S&P 500 (which, after all, is composed of the 500 largest companies and overweights monopolies or oligopolies in broad industries).

The S&P 500, however, has been basically flat over that same time period, holding at the 7700 level. It basically has a leg down over the course of the week, and then always pumps on Friday to regain the previous level. I'm not sure if it's government intervention or irrational exuberance in a small set of AI stocks, but the divergence between the broad market and the S&P 10 is becoming increasingly noticeable.

But as you say, it's the Iran war and other factors that are to blame. Inflation is lurking in the background but various things will always appear in the foreground to occupy the market's attention for a bit.

But on the scale of years inflation will dominate all transient idiosyncracies.

I'm not convinced of that, and I don't think the market is showing that it's convinced. At least not abnormal, above-2% inflation like we've had for the last 5 years.

I think there's a decent chance that Warsh gets inflation under control. The recent rise in bond yields is 100% due to Fed action: the Fed stopped rolling over long-term treasuries and MBS into like-kinded securities in June, instead rolling them over to short-term treasuries. This shrinks the Fed's balance sheet on the long end of the curve and adds to it on the short end, just like Warsh said that he would do. It's net-neutral for the Fed's balance sheet as a whole, but the effect is to push up long-term yields, hold short-term yields steady (which have a floor of the Fed funds rate), and steepen the yield curve.

The next step - and Warsh has made no secret that this is his plan - is that once the long-term Treasury market finds an equilibrium without Fed support, use that information to figure out what the neutral rate is, and set short-term rates accordingly. The price action we're seeing is a strong indication that the neutral rate is significantly higher than anybody expects right now.

The bond market is also not expecting significant inflation over the next 10 years. You can see this through the TIPS spread, the difference in rates between the 10-year TIPS and the 10-year Treasury bond. It currently stands at about 2.35%, indicating that the market as a whole expects about 2.35% (CPI) inflation over the next 10 years.

https://en.macromicro.me/collections/51/us-treasury-bond/846...

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