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.

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