Can Wall Street’s bulls keep climbing a ‘wall of worry’?

Business

Federal Reserve Chair Jerome Powell has a clear message for investors: Don’t stress. We’ve got this.

What’s happening: At a press conference Wednesday, Powell reiterated that the central bank does not plan to roll back its massive stimulus efforts until the economic recovery from the pandemic is complete. Wall Street cheered his remarks, sending stocks to fresh records.

But by Thursday morning, the mood had changed. Investors dumped US government bonds, sending the yield on the benchmark 10-year Treasury up to 1.738%, the highest level in more than a year. Nasdaq Composite futures fell sharply, indicating tech shares could be primed for another drop.

The shift displays the mental tug-of-war playing out across markets. While many investors are gearing up for an economic boom later this year, anxiety is growing about adverse side effects — namely inflation, which could force the Federal Reserve to raise interest rates or taper bond purchases sooner than expected.

“Strong economic growth — the kind we have been expecting since last summer, closes the output gap and leads to inflationary pressure,” Bank of America’s equity strategists told clients Wednesday. “No surprises there.”

The economic picture is brightening. Thanks to President Joe Biden’s $1.9 trillion stimulus package and the vaccine rollout, Fed officials now project that US gross domestic product, the broadest measure of economy activity, will climb 6.5% this year, more than the 4.2% projected in December.

Meanwhile, the unemployment rate is expected to fall to 4.5% by year-end. By 2023, the jobless rate could be back at 3.5%, where it sat before the pandemic hit.

We’re not there yet, Powell acknowledged. Another 700,000 first-time claims for unemployment benefits are expected in Thursday’s report from the Labor Department. That would be the lowest number of claims since the pandemic started, but still well above the 200,000-some claims typically registered before the virus arrived.

The Fed chair emphasized that the central bank plans to scrutinize the latest data when making decisions instead of relying on projections.

“We’ve said that we would continue asset purchases at this pace until we see substantial further progress,” Powell said. “And that’s actual progress, not forecast progress.”

Even so, some on Wall Street are wondering if the Fed’s choice to sit tight — potentially through 2023 — could mean it’s forced to take more dramatic action down the line, and fear that inflation could stick around longer than officials think.

“At the moment this is all fine if the Fed’s assumption that any inflation is transitory is proved correct,” Deutsche Bank’s Jim Reid told clients Thursday. “However, if the market doubts the transitory nature of inflation at any point that’s when the fun and games start.”

The team at Bank of America is more sanguine. “There is always some reason or the other since the start of this bull market to complain,” its strategists said. They think investors can climb the “wall of worry,” though, given that markets are awash with cash and corporate earnings growth looks primed to jump. Their advice? “Stay bullish.”