Regime Change for the Equity Risk Premium?

The US equity risk premium is narrower than at any time since the Global Financial Crisis ended, and closer to the pre-crisis mean than the post-crisis mean. The ERP is a mean-reverting indicator, so this suggests that stocks are due for a more serious correction than the three small ones so far this year. But the ERP mean is non-stationary, and we have to ask whether we are on the cusp of a new regime. Two credible candidate explanations emerge. First, there are large and durable future productivity gains to be derived from the reorganization of work after the pandemic. Second, the Fed has abandoned the fallacious Phillips Curve as a policy tool. This means the Fed will no longer mistakenly cause recessions out of the false belief that low unemployment causes inflation. At the same time, average inflation targeting will make the Fed more patient about inflation itself. Fewer recessions mean less risk, and less risk means a durably narrower equity risk premium.