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Chief economist update: The pause that refreshes

The music has stopped, should we cease dancing?

Two consecutive days of losses on Wall Street is a very long time in financial markets so much so that "pundits struggle to explain stocks stumble", according to the Australian Financial Review (AFR).

But as I like saying, Christmas doesn't come everyday. No siree!

Still, the performance of the US equities market - as measured by the S&P 500 index - this year to date had been up 2 to 1 (up 10 weeks, down 5 weeks) for an overall handsome sum of 10.1%.

But naysayers have a point, uncertainties remain. There's the resurgence of infections, blood clots, slow rate of vaccinations (threatened to be overcome by more infectious and more deadly variants) and, away from the madding crowd ... rising geo-political tensions - US versus China, Russia and Iran.

It's also no secret that the S&P 500's valuation are stretched. Factset data shows it's now trading at a P/E (price-to-earnings) ratio of 22.6. This is way beyond its five-year (18.1 time earnings), 10-year (16.1 times), 15-year (15.2 times), and long-term (14.4%) averages.

Plus, the back-up in US long bond yields due to rising inflation expectations is also certain to depress stock market valuations while at the same time devaluing the US Federal Reserve's efforts at guiding the economy out of the pandemic.

To be sure, US president Joe Biden's fiscal injections are cause for concern with regards to stoking inflation.

As Factset reports,

"Biden's stimulus plan continues to evolve, with White House readying an "American Families Plan" focused on domestic priorities as a companion to the $2.25T infrastructure effort. Washington Post reports plan expected to call for ~$1T in new spending and ~$500M in new tax credits."

So much money could flood the system and lift inflation. But have no fear, the Fed is here.

In an exclusive, Reuters prints Fed Chairman Powell's letter to Senator Rick Scott that, "we are fully committed to both legs of our dual mandate - maximum employment and stable prices.

In not so many words, the Fed is on top of inflation concerns.

"We do not seek inflation that substantially exceeds 2 percent, nor do we seek inflation above 2 percent for a prolonged period." Besides, while the Fed expects measured inflation to accelerate, it also believes this to be transitory.

At the end of the day, US monetary and fiscal policies would remain not only accommodative but stimulative until they're both convinced that recovery has become sustainable.

Two down days could be the pause that refreshes.

You should be dancin', yeah! (Bee Gees)

Read our full COVID-19 news coverage and analysis here.

Read more: FactsetS&PAustralian Financial ReviewFamilies PlanFed Chairman PowellSenator Rick Scott