In addition to driving stock prices higher, the Fed’s QE policies have succeeded in boosting inflationary expectations as measured by the spread between the 10-year Treasury yield and the comparable TIPS yield. Indeed, this spread is highly correlated with both the S&P 500 stock price index and the forward P/E of the S&P 500. The spread peaked at a high so far this year of 2.64% on September 14, matching the QE2 peak on April 8, 2011. It dipped back down a bit to 2.42% yesterday.
This suggests that the market could make new highs over the rest of the year if expected inflation does the same. For this to happen, the lame duck session of Congress would have to pass legislation that would postpone the fiscal cliff for a few months and also raise the debt ceiling.
By the way, the price of gold has been tracking the debt ceiling for quite some time. In addition, the price of gold has been highly inversely correlated with the 10-year TIPS yield, which was down to a negative 0.78% yesterday. Presumably, the negative yield reflects strong demand for this bond because it provides inflation protection.
Today's Morning Briefing: The Fed & the Cliff. (1) Bernanke takes credit for the bull. (2) Bernanke’s Put. (3) QE and LDR (law of diminishing returns). (4) Inflationary expectations driving stock prices. (5) Fixing or postponing fiscal cliff problem would be bullish. (6) How does QE boost stock prices? (7) Retail stock investors have been MIA. (8) So have pension funds and foreign investors. (9) Fed’s policies have caused a bond buying panic. (10) Corporations have raised lots of money in the bond market and repurchased shares. (More for subscribers.)