Policy Has Tightened a Lot. Is It Enough?
Comment of the Day

May 09 2022

Commentary by Eoin Treacy

Policy Has Tightened a Lot. Is It Enough?

Thanks to a subscriber for this article by Neel Kashkari for the Minneapolis Fed. Here is a section:

First, at a minimum, the FOMC must follow through on the forward guidance of federal funds rate increases and balance sheet reduction that we have already signaled in order to validate the repricing that has taken place in financial markets.

Second, we will need to see whether the supply issues that have contributed to high inflation begin to unwind and/or if the economy is in a higher-pressure equilibrium. I wrote about this possibility seven weeks ago. Unfortunately, the news from the war in Ukraine and the COVID lockdowns in China are likely delaying any normalizing of supply chains. If supply constraints unwind quickly, we might only need to take policy back to neutral or go modestly above it to bring inflation back down. If they don’t unwind quickly or if the economy really is in a higher-pressure equilibrium, then we will likely have to push long-term real rates to a contractionary stance to bring supply and demand into balance. The incoming data over the next several months should provide some clarity on these questions.

Finally, we will need to continue to assess where neutral is. If the economy is in fact in a higher-pressure equilibrium, that might indicate the neutral long-term real rate has increased, which would then require even higher rates to reach a contractionary stance that would bring the economy into balance.

Eoin Treacy's view

Kashkari is not a voting member this year, so he has some leeway to speak his mind. The big takeaway is he has historically been viewed as a dove, so for him to talk about the need to create a recession to combat demand strength is notable. That is feeding into the current recession scare and financial conditions tighten.

One of the things we talk about at The Chart Seminar is leaders lead for a reason and they lead in both directions.
The Nasdaq-100 was the clear leader in this cycle. The delivery of 4G connectivity coupled with a decade of close to zero interest rates, drove phenomenal growth in asset prices. The biggest beneficiaries of those twin trends have become some of the largest companies in the world.

The unifying characteristic for Apple, Amazon, Alphabet, Microsoft, Meta Platforms, Netflix, Nvidia and Tesla is they did best from leveraging broadband and low interest rates to capture market share.
Bond yields have doubled, quantitative tightening is being priced in and these companies are running into the law of large numbers. It is not possible to double subscribers when you are already counting in billions.

This group of eight companies is now underperforming the total market and still represents a $9 trillion market cap (versus $12.3 in January). Apple is the only one that has not yet broken lower. It is coming down to test the $150 area and will need to rebound soon if the trend is to remain consistent. That’s not an especially likely scenario when everything else is reverting towards the 1000-day MA.

Bitcoin is breaking lower. It was designed to benefit from the debasement of fiat currency when it was first released in 2008. The rising Dollar and contracting value of central bank balances sheets weigh on its price.
The Philadelphia Semiconductor Index has also broken down and is trending lower. The best-case scenario is the 1000-day MA will offer support.

The big question for growth sectors is what will it take for central banks to relent and make additional liquidity available? We have been conditioned to believe this is inevitable because we have all seen exactly that on successive occasions for decades. Inflation and geopolitical uncertainty suggest central banks will not reverse course until they can claim victory over inflation.

There is good reason to expect growth to moderate over coming quarters and commodity price appreciation is unlikely to be as pressing either. Nevertheless, central banks view this as a credibility issue so they are unwilling to be seen to do nothing.  

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