The Fed's new inflation target tees up strong returns for unloved stocks, Jefferies says

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  • The Federal Reserve’s new inflation target stands to accelerate the ongoing value rotation and aid unloved sectors, Jefferies said. 
  • The framework sets a higher bar for future rate hikes, as the Fed now aims to have temporary bouts of above-2% inflation.
  • Lagging sectors like energy, materials, and financials can benefit as easy monetary conditions lead investors to take on more risk, the firm said.
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The Federal Reserve is poised to maintain an accommodative policy stance for the foreseeable future. That playbook should serve as a major boon for the market’s long-neglected stocks, Jefferies strategists said Wednesday.

The central bank updated its inflation target in August after years of weaker-than-expected price growth. Known as average inflation targeting, the framework seeks inflation that averages 2% over time and, therefore, allows for periods of above-2% inflation. The new policy signals the Fed will keep easy monetary conditions in place well into the US economic recovery.

Stocks have surged to record highs in recent weeks on expectations that stimulus from Congress and the Fed will boost economic activity. Yet clients are now wondering when rising Treasury yields will affect stock investing, the strategists led by Sean Darby said.

While new stimulus and recovery optimism recently prompted discussion as to when the Fed might tighten its policy stance, Jefferies sees the central bank as far from such tapering. The new inflation target sets a higher bar to clear for future rate hikes, and the continued rotation to value stocks will lift unloved sectors including energy, financials, and materials, the team added.

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For one, the unemployment rate remains well below the Fed’s target. The dollar is still expensive relative to other currencies. Junk bonds fell to record-low yields on Tuesday, and inflation expectations remain well below the highs seen at the same point in the financial crisis.

These indicators and others suggest financial conditions continue to loosen and that inflation expectations are “nowhere near as high” for the Fed to meet its AIT goals, the team said.

In turn, rising Treasury yields will only hit stocks with high price-to-earnings ratios as profit growth slows or decelerates, they added.

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