Is The Dow Ignoring The Coming Tightening Cycle?

 | Aug 04, 2017 06:30AM ET

Key Points:

  • DJIA breaches 22,000 level and continues to move higher
  • Market may be underestimating the impact of either a tightening or tapering phase
  • Keep a close watch on Federal Reserve policy and sentiment in the near term

The Dow Jones Industrial Average recently crossed the mythical 22,000 mark in open defiance of potential monetary tightening coming from the U.S. Federal Reserve. As many of you may know, there is a direct negative correlation between interest rates and equity prices so it’s especially surprising to see the Dow forging ahead despite all the expectation setting for either a rate hike or a taper. Subsequently, it begs the question as to whether equity investors completely lost their minds…or do they know something the rest of us do not.

At a guess, maybe equity investors have little faith in the Fed’s ability to follow through on their threats of a massive balance sheet taper given the lack of strong inflationary pressures. On this point, they may be correct given that the Fed has a poor track record of telling the truth when it comes to setting forward expectations.

However, although inflation has recently dipped, it was largely due to a fall in crude oil and energy prices and really didn’t impact the PCE Deflator or the Core very much. So there are still building inflationary pressures, as well as a strong disconnect between the public and the Fed, that provides a relatively dangerous environment for equity prices.