Looking at what could go wrong for the stock market, one macroeconomic factor jumps out at me.

That’s right, we’re going to talk about inflation some more. Risks of inflation are still rising.

You know that old saying… Be careful what you wish for? Well, it seems to be haunting Federal Reserve Chair Jerome Powell.

Last October, Powell noted…

“The risks of overdoing it seem, for now, to be smaller. Even if policy actions ultimately prove to be greater than needed, they will not go to waste. The recovery will be stronger and move faster if monetary policy and fiscal policy continue to work side by side to provide support to the economy until it is clearly out of the woods.”

Monetary policy is the Fed’s responsibility. For more than a decade, the Fed has been aggressively adding money to the economy.

Fiscal policy is spending authorized by Congress. For most of the past decade, a divided government resulted in a restrained fiscal policy. Now that Democrats control both Congress and the White House, fiscal restraint could give way to exuberance.

That’s not a partisan statement. It’s just a very real possibility.

Now that the $1.9 trillion stimulus bill has passed, Congress is looking at a $2 trillion infrastructure bill. Budget increases are likely to add to the spending. This has pushed interest rates up, which you can see in the chart below.

This is becoming a global threat to the economy.

In Japan, where interest rates have been unusually low since the beginning of the century, rates are back in positive territory.

In Europe, the picture is less clear.

Rates may have bottomed in December. For now, all eyes are on the European Central Bank, which is struggling to provide clear guidance because fiscal stimulus is set to begin in Europe later this year. Although the program was approved last year, governments move slowly in Europe.

What This Means For Us

Eventually, rates will rise enough to be attractive to investors. That comfort level is impossible to predict, but if investors get nervous about stocks, they could start selling stocks and jump into bonds. This is a long-term concern, but could be just months away if inflation picks up.

In the short run, investors are increasingly bullish. SPDR S&P 500 ETF (NYSE: SPY) is close to a “buy” signal on my Income Trader Volatility (ITV) indicator. As I always note, ITV is similar to the VIX (volatility index) in that it rises as prices fall. At the close last week, ITV was near its moving average (the thin blue line in the bottom portion of the chart).

Continued upside progress in SPY will flip this indicator to a bullish state.

That would confirm my Profit Amplifier Momentum (PAM) indicator, which turned bullish at last Friday’s close. PAM is shown in the bottom panel of the SPY daily chart below.

PAM is designed as a short-term indicator. It’s possible ITV will confirm this signal in the next few days. If it does, that will tell us traders to expect fiscal stimulus to be bullish for the economy. Then it will be up to the Fed to contain inflation in order to keep the bull market going.

I know this may sound like a broken record, but I will keep reiterating that this is why I’m focused on shorter-term strategies right now. And you should be considering some short-term alternatives, too.

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