Stocks & the Fed (Excerpt)

A melt-up could propel the S&P 500 to my yearend target of 1665 before the middle of the year. That might be too much of a good thing. Such exuberance for stocks would probably reflect and contribute to stronger-than-expected economic growth. The market could then have a nasty correction during the second half of the year if we learn that Fed officials are increasingly alarmed that they are doing it again, i.e., pumping air into another stock market bubble.

Stock investors were undoubtedly happy to see on Thursday of last week that the core personal consumption expenditures deflator rose only 1.3% y/y during December, the lowest since May 2011. It’s also well below the Fed’s 2.5% red line. In Friday’s employment report, wages of all workers rose 2.1% y/y during January. That’s still very subdued, though up from last year’s low of 1.5% during October.

On the other hand, the expected inflation rate embedded in the spread between 10-year Treasuries and TIPS was at 2.6% on Friday, and seems set to move higher. If it does so, that could put the Fed in a real box. If expected inflation spikes up later this year, there could be more than one or two dissenters in the FOMC. Esther L. George, the President of the Kansas City FRB, was the lone dissenter with a vote at the January 29-30 meeting of the FOMC because she “was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations.”

Today's Morning Briefing: Goldilocks Is Back. (1) Not too cold, not too hot. (2) The downside of a melt-up. (3) Goldie’s shoes. (4) Too many charging bulls? (5) Room for more bullish sentiment and spreads. (6) P/E of 14 = 1600 on S&P 500 & 15 = 1700. (7) Payroll report was just right. (8) Next big debate at the Fed: Blowing bubbles again? (9) Inflation remains on ice, but expectations are heating up. (10) Barrage of bullish data sends bears packing. (11) Go With the Flow. (12) What’s leading and lagging the 2013 rally? (More for subscribers.)