If Stocks Don't Fall, the Fed Needs to Force Them
Comment of the Day

April 06 2022

Commentary by Eoin Treacy

If Stocks Don't Fall, the Fed Needs to Force Them

This article by Bill Dudley may be of interest to subscribers. Here is a section:  

So far, the Fed’s removal of stimulus hasn’t had much effect on financial conditions. The S&P 500 index is down only about 4% from its peak in early January, and still up a lot from its pre-pandemic level. Similarly, the yield on the 10-year Treasury note stands at 2.5%, up just 0.75 percentage point from a year ago and still way below the inflation rate. This is happening because market participants expect higher short-term rates to undermine economic growth and force the Fed to reverse course in 2024 and 2025 — but these very expectations are preventing the tightening of financial conditions that would make such an outcome more likely.

Investors should pay closer attention to what Powell has said: Financial conditions need to tighten. If this doesn’t happen on its own (which seems unlikely), the Fed will have to shock markets to achieve the desired response. This would mean hiking the federal funds rate considerably higher than currently anticipated. One way or another, to get inflation under control, the Fed will need to push bond yields higher and stock prices lower.

Eoin Treacy's view

Fed and ex-Fed officials appear to have all been given the same talking points. They are willing to break something if that is what is required to bring inflation down. Reactions of 20% have historically been enough to create deflationary growth fears and for the Fed to relent.
Considering how much financial assets rallied during the pandemic it is reasonable to assume that unwinding that surge is the basic requirement for attempting to get inflation back within reasonable limits. That suggests the S&P500 will eventually test the 3500 area.

Bitcoin is one of the primary liquidity and risk appetite barometers. It is currently pulling back from the region of the 200-day MA. The rally at the end of March broke the sequence of lower rally highs so the price will need to find support above $37500 if support building is to continue to be given the benefit of the doubt.

By ranging for much of the last year, the price has unwound most of the overextension relative to the 1000-day MA. That suggests bitcoin in a more mature phase of its medium-term pause than stock markets. Of course, that assumes the 1000-day MA will continue to offer support for the secular trend.
The faster prices the get to those levels the fewer interest hikes will be required. Mortgage rates hit an 11-year high this week. The 200-basis point rise adds an additional $115 a month per $100,000 borrowed to the mortgage payment. That’s before the higher property taxes from higher priced homes are factored in.

Investor psychology usually creates demand when interest rates rise because buyers want to lock in rates. However, at some point the reality of being no longer able to afford ever higher prices registers and prices begin to decline. Home price appreciation and the associated jump in rents has been one of the primary causes of inflation over the last eighteen months.

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