CAMBRIDGE – The US stock market has been on a tear over the past two years. The S&P 500 has increased by roughly 40% since President Joe Biden assumed office in January 2021 and, along with the Dow Jones and NASDAQ, is repeatedly setting new records. Moreover, the dollar has strengthened sharply against every major currency, while the price of gold surged to an all-time record of $2,470 an ounce earlier this month.
Economists and commentators have struggled to explain these trends. While the increase in gold prices could be attributed to elevated risk perceptions stemming from political and geopolitical uncertainties, this explanation does not account for the booming stock market. Conversely, the decline in the VIX volatility index since 2022 might explain the US stock-market rally but not the spike in gold prices.
One possible explanation for the boom in equities is the rapid emergence of artificial intelligence since late 2022, which has caused shares of companies like chip maker NVIDIA to skyrocket. But while the tech sector has experienced the biggest gains and attracted the most attention, the market has been rising steadily across the board, even excluding tech stocks.
Some believe that the explanation for the rising prices of stocks and gold lies with US monetary policy. US interest rates have risen over the past two and a half years, including long-term rates. This should have reduced stock and commodity prices. Typically, stock markets fall when interest rates rise, assuming other factors remain unchanged. The reason is that interest-rate hikes reduce the present discounted value of future corporate earnings, prompting investors to shift from equities to bonds. Moreover, the price of gold also tends to fall when real (inflation-adjusted) interest rates rise and vice versa.
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