The markets are famous for reacting to what they think is going to happen, rather than what happened in the past. In this regard the markets are an indicator of the future. Like any indicator, the markets are not always accurate, but they are an indicator that bears watching. For example, for the past two months, the markets have pushed long-term interest rates higher.
This has happened despite the Federal Reserve Board keeping short-term interest rates close to zero — and in their last statement, they are willing to keep them near zero for a significant period in the future. So why the dichotomy? First, we must point out that the Fed controls short-term rates directly, but long-term rates indirectly. If the markets feel the Fed is not being diligent against inflation, long-term rates will rise regardless of what the Fed does or says.
On the other hand, the Fed is optimistic that economic growth could be robust this year. Especially since the stimulus package has been enacted. They also admit there could be a pick-up in inflation. Because of the slack in the economy – namely almost 10 million jobs not recovered – they feel there is room for growth without overheating the economy in the long-run. The markets obviously are sending another message. Who is right? Does someone out there have a crystal ball?