Too Much Faith in the Fed

What if the U.S. economy fails to pick back up from its dismal first quarter? Then the U.S. Federal Reserve will push off the frequency and the magnitude of any increases in overnight lending rates. That’s what the U.S. stock market is telling investors, as the S&P 500 and NASDAQ break above record highs. That’s what the U.S. bond market is telling investors, as the yield on the U.S. 10-Year Treasury continues an ominous descent.

Perhaps more surprising than the “bad economy-good market” dynamic is the degree of investor complacency. While the Chicago Board Options Exchange (CBOE) Volatility Index (VIX) is not necessarily registering utter disregard for the possibility of a stock sell-off in the next 30 days, the VIX is approaching 9-month lows. Indeed, the worse the economic news over the previous four months, the less insurance (via “puts” and “calls”) the investment community has required.

VIX 1 Year

There are those who dispute that the U.S. economy is struggling, and that perhaps stock strength is a reflection of economic confidence. After all, aren’t equities supposed to keep rising until and unless genuine recessionary pressures build? If that thought were bullet-proof, stocks would be struggling like they did during the euro-zone crisis in 2011 or like they did during the financial collapse in 2008. The Bloomberg ECO U.S. Macro Surprise Index – an index which measures whether economic data is beating forecasts or missing expectations – is hanging out at levels not seen since either crisis.