Global stock markets sold off hard on Sunday night (the US markets were closed on Monday so they couldn't react), and then sold off even harder last night. This morning, the Federal Reserve announced a surprise intra-meeting rate cut of .75%, bringing the Fed funds rate down to 3.5%. (Of course, this is one of the most widely anticipated "surprises" we've ever witnessed, but never mind that.)

Beyond all the dramatic headlines, there are a few very instructive details about today's move.

Instructive detail #1: Due to the Monday holiday in the US, the only piece of noteworthy financial news between Friday and today was that global stock markets sold off. Then, this morning, the Fed slashed rates in a highly unusual intra-meeting move.

Significance: The Fed heads constantly claim that they react to the "real economy," not the markets; that they will not bail out investors; and that they only target the second-order effects of the markets on real economy price stability or employment and not the markets themselves. But the last few days' sequence of events -- a market selloff in the absence of any real economy news, immediately followed by a huge surprise rate cut -- proves this is not true. The Fed is clearly reacting directly to moves in the stock market, and furthermore obviously seeks to use monetary policy to influence the stock market as well as the real economy.

Instructive detail #2: This move comes at a time when the latest year-over-year increase in inflation as measured by the CPI weighed in at 4.1%. This means that the Fed funds rate is now well below the trailing year's rate of CPI inflation -- something that hasn't happened since the last reflation campaign in the wake of the tech stock bubble burst.

Significance: The last round of negative real Fed funds rates occurred when we were experiencing a recession, when the stock market was in the tank, and when fears of a deflationary spiral were widespread. Yet the effects of the rate cuts were actually to cause CPI inflation to eventually get to uncomfortably high levels and to cause an inflationary speculative bubble in housing.

Now, here we are in a likely recession, with the stock market falling hard, deflation fears widespread, and the Fed cutting rates to below the rate of CPI inflation. Sound familiar? The Fed's interest rate cuts may not keep the stock market from declining or keep us out of recession, but they are putting yet more inflationary pressure in the pipeline. This will eventually show up as increased goods price inflation or more asset inflation (and possibly yet another asset bubble).

Instructive detail #3: Long-term bond yields are plummeting this morning. As this article is being written, the 10-year US Treasury Note is yielding 3.52% -- also well below the trailing rate of CPI inflation. Here we have the Fed forcing real short-term rates into negative territory, the effect of which is to increase the supply of money and credit in the system. Meanwhile the government is gearing up to release a "stimulus package" financed with borrowed money (a huge amount of which comes from foreigners), which will release yet more money into the system and increase our already huge debt levels. This is all inflationary over the long haul, but long yields are dropping like a rock.

Significance: Neither the Fed nor the government are all that concerned about inflation in and of itself. They are only concerned to the extent that inflation causes long-term yields to rise, making it tougher for our extraordinarily debt-dependent society to keep on borrowing. And this just isn't happening. The bond market is ignoring long-term inflationary pressures, giving carte blanche to the Fed to inject more money into the system and the to government to keep on racking up the foreign debt.

A historical aside: Many people claim that falling long-term yields are the bond market's way of telling us that inflation will remain low. Our response is to wonder why you would listen to the bond market on this question given its long history of mispricing inflation risk. To sum up the last several decades: first, the bond market was massively underpricing future inflation risk in the 1960s and early 1970s, and bond yields climbed the entire time after the inflation had already happened. By the early 1980s, the bond market had overshot and was massively overpricing future inflation risk. Yields fell for the next two decades. By the time they hit their bottom in 2003, the bond market was once again massively underpricing inflation risk. We feel strongly that it still is.

Conclusion

• The Fed does directly target financial markets and specifically the stock market after all.
• The current policy of forcing money and credit into the system with negative real interest rates is inflationary, especially in combination with foreign debt-financed government stimulus spending.
• These policies will continue for as long as the bond market allows it.
• And the bond market is effectively telling the Fed and the government, "Knock yourself out."

As mentioned earlier, these inflationary policies probably will not prevent either a stock correction or a recession, especially in those areas where the prior inflationary bubble caused the most excesses. But they will cause eventual inflation somewhere in the system.

Right now, the inflation-beneficiary asset classes that we favor are selling off along with everything else. But the highly inflationary policy response to the selloff only strengthens their long-term fundamentals. And further deterioration in the stock market or economy will be met with yet more money being pumped into the system.

The uglier things get in the short term, in other words, the better things look for long-term investors who are positioned for the inevitable inflationary aftermath of our nation's reckless monetary and fiscal policy.