The Fed’s QEs and Operation Twist all seemed to be responses to falling inflationary expectations. So far, they all successfully boosted those expectations. The inflation rate embedded in the spread between the 10-year Treasury yield and the comparable TIPS yield jumped by 39bps from 2.25% on August 31, when Bernanke spoke at Jackson Hole this year, to 2.64% on Friday. That matches QE2’s peak on April 8, 2011.
The S&P 500 has been highly correlated with the 10-year Treasury market’s expected inflation rate. Rising inflation tends to be bullish for stocks because it boosts revenues and earnings as long as prices are rising faster than costs. In the past, inflation was only bearish when the Fed tightened monetary policy to bring down inflation. Since the financial crisis started in 2008, the Fed’s goal has been to avert deflation with unconventional monetary easing.
Today's Morning Briefing: Stocks & QE3. (1) “What’s not to like?” (2) Eight reasons why QE is bullish for stocks. (3) Don’t fight the Chairman. (4) Encore, encore! (5) NZIRP is purgatory for conservatives. (6) It might work this time. (7) Basking in the warm glow of inflation. (8) A weaker dollar may be boosting earnings already. (9) No more Lehmans! (10) Lenders of last resort to everyone. (More for subscribers.)