Perhaps it was in reaction to the news that China indicating that inflation was not likely to be a serious problem in the near future. Federal Reserve Chairman Ben Bernanke also had a very relaxed attitude towards inflationary expectations and asset prices. In a written response to Senator Jim Bunning (KY-R), Bernanke wrote:
The bulk of the evidence indicates that resource slack is now substantial. I continue to expect slack resources, together with the stability of inflation expectations, to contribute to the maintenance of low inflation in the period ahead.
In addition, the Fed Chairman doesn’t believe that there is an asset bubble:
Responding to questions about asset prices, Bernanke said “there is not much evidence to suggest that the stock market is currently in a bubble.” The Standard & Poor’s 500 Index has rebounded 28 percent in the past year while remaining 30 percent short of its high in October 2007.
Well, we can more or less guess that the FOMC statement will have a dovish tone.
A commodity and asset inflation friendly environment?
This sort of attitude by the Fed and the Chinese are ingredients for another Bubble and should continue to be bullish for commodity prices and bearish for the USD. The chart below shows the ratio of Amex Gold Bugs Index (HUI) to the S&P 500, indicating that gold stocks remain in a relative uptrend relative to the general market.
Dave Rosenberg explained yesterday why inflationary expectations are creeping higher:
It could have more to do with government mandated cost-push inflation than anything related to consumer demand-pull inflation. But we did see in today’s Investor’s Business Daily an article, which stated that governments have enacted 297 protectionist trade measures in the past year. (Amazingly, it was just over a year ago when the G-20 meeting was held in Washington when it was agreed that no such anti-trade measures would be taken.) The number of ‘planned measures’ has risen by 50 (!) in just the past three months — the pipeline keeps growing. This is why gold is a buy on pullbacks … like the one we have on our hands right now.
As well, my Inflation-Deflation Timer model continues to sport an “inflation” reading, which has been in place since July.
Financials signaling risk ahead
On the other hand, the relative behavior of the banking and financial sector is a warning sign for the longevity of this equity rally. The BKX made a plateau relative to the S&P 500 in the August to October period and has been falling since.
Watch the market reaction
If we do get the dovish statement, then I would watch how the market reacts. Does the “risk trade”, i.e. equities, commodities, etc., rally? If so, then how big is the rally?
I will be watching how commodities, exchange rates, equities and the financial sector reacts to the FOMC announcement for clues of future market direction.