As 2019 ends and 2020 kicks off, we are writing a series about markets and the economy. The series is mainly visual, anchored with charts, but includes brief bullet point explanations of each chart.
Throughout the series, we examine the magic of the present bull market. We explore why we are at record levels in the S&P 500 and how we got here. Our first essay talked about the strong labor market and solid consumer confidence, while this essay turns to benign inflation and low interest rates.
Other essays in this series will examine what’s been interesting and even unique about this bull market and, ultimately, what threatens the bull market in 2020 and beyond. To read the previous essays in the series please visit our blog.
The long-term average U.S. inflation rate is
3.24%, but for this bull market we’ve seen inflation average under 2%.
Since 2012, the U.S. Federal Reserve has
publicly stated an inflation goal of 2%.
Inflation being below average and below target has
allowed the Federal Reserve to institute highly accommodative monetary policy
throughout the bull market.
The adage “don’t fight the Fed” has surely been
true during this bull market. A generous
Fed has led to a docile market.
Not only have interest rates and inflation been
low in the U.S., but they have also been low throughout the world.
A low Federal Funds rate (an interest rate the
Federal Reserve directly controls) has much influence over short-term rate
benchmarks like 3-Month LIBOR.
3-Month LIBOR is a benchmark that banks
frequently use to price debt. A low
LIBOR makes borrowing more appealing and as such stimulates the economy. This is surely the case with LIBOR at 1.89%
compared to its long-term historical average of 3.74%.
Low inflation and an active Fed have led to low
longer-term rates as well. The 10-year
presently yields 1.90%, substantially below its long-term average of 6.12%.
The 10-year has a heavy influence over mortgage
rates. Low mortgage rates have kept the
housing market healthy during this bull market.
Most importantly, the 10-year impacts stock
valuations. A low long-term interest
rate theoretically makes stocks more valuable as the discounted present value
of future corporate earnings are worth substantially more at low rates relative
to high rates.
In our next note, we will look in even greater detail at how the bull market could continue into 2020. We hope your holidays are off to a great start!
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