Let me elaborate more on the impact of inflation and bond yield(interest rate) on stock markets. US 10-year bond yield reached 1.61% last week. It surged upwards, but swiftly pulled back to 1.4%. Bond yield and bond price(discounted present value) are negatively correlated: when yield soars, price plummets. Some investors have been selling incessantly recently, and those in possession of national bonds are mostly giant financial institutions or funds. So the question is: why have they been selling?

As stated before, market rescue measure is in a transition stage. From 2009 to 2020, it was monetary policy that saved the market, mainly through QE(quantitative easing). QE means the ultimate buyer of bonds is the government. The government told you they would buy them all in the end, regardless of the price. With such a price that would only go upwards, bonds entered a bull market. As a result, their yield was dragged to extreme lows. In Japan and some European countries, buyers fell over each other to buy national bonds even when negative yield was found. We have to remember there’s only one reason for that: the government said it would buy them all.

Since the beginning of this year, the US has been preparing to save the market with fiscal policy, i.e., increasing government expenditure. If both monetary and fiscal policies are on, the stimulus will be way too much, leading to overspeculation in bonds, hence a new crisis. Isn’t one asking for trouble by doing so? So, when it is confirmed that the US is going to save the market with fiscal policy, it insinuates that monetary policy is withdrawing. Once QE bows out of the market, it means there is no guarantee that the government will buy all national bonds finally, then the giant financial institutions will take action in advance.

Since the market fears QE pulling out sooner or later like the Federal Reserve retracting in those years, the Federal Reserve now still stresses it does not have a plan to call a halt to QE. To stabilize the market, the Reserve Bank of Australia even bought in long-term bonds worth AUD4 billion for the bond yield soared too fast. It is just a supposition that monetary and fiscal policies are not launched simultaneously. As the Federal Reserve said it does not have a plan to call a halt to QE, why does the market take it so lightly?

The reason is inflation. There are two kinds of inflation: cost-driven inflation and demand-driven inflation. Simply put, the former happens when costs of incoming products increase; the latter occurs when market prices are pushed up by the fact demand exceeds supply. Last year, as the pandemic wreaked havoc, production plants stopped operating. Since the start of this year, demand has been picking up, while supply has been catching up. In the short run, market prices will go up. When production capacity is stepped up to refill stocks, market prices will pull back in the short term. Saving the market with fiscal policy needs persistent demand for goods. The minimum wage policy to which the Left aspire will boost costs. The entire playbook asks for inflation.

When inflation comes on the scene, monetary policy is bound to quit. Even though the Federal Reserve said it does not have a plan to do so, the market surmises from what it is doing now that it will, which is the current misgiving and the cause of the shock.

After all, will stock prices go up or down? We have to wait till Friday. With the market waiting to see if the Federal Reserve will take action against the soaring of bond yield, the Fed chair and its board members will make remarks on Friday. My humble opinion is that the Federal Reserve will calm the market equivocally, and if bond yield keeps soaring, it will declare some moderate measures which are neither here nor there. So, will the market hover high, and reach record highs? That’s anybody’s guess. But I predict that a large-scale adjustment is going to take place within three months.

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