Friday, May 08, 2009
Interest rates, commodity prices, the dollar, and the stock market
I have another view on the auctions.
The entire problem experienced by the stock market and the economy over the past 7 months has been an "uncertainty" shock. People became fearful because the value of assets and the banks that held them was called into question. Assets were therefore priced on the basis of the worst that could happen. People began to anticipate economy wide deflation. For this reason the preferred asset was treasury securities. Commodity prices fell (gold, silver, especially crude oil) and the dollar strengthened. All these things were manifestations of a monetary policy that was too tight in the face of this uncertainty shock.
But the worst is now over, and the markets are beginning to realize that. The fact that yields on treasury securities are rising and that auctions are "failing" shows that people no longer expect widespread asset price deflation - that the Federal Reserve's policy of reflation/inflation is working. This is going to pull the economy out of its slump. Asset markets are slowing returning to normal. Commodity prices are strengthening and the dollar is weakening - also signs of reflation.
So for these reasons I regard rising interest rates, rising commodity prices and a falling dollar as very, very bullish for the stock market. These phenomena reflect the success of the U.S. governments reflationary policy in staving off a second great depression.