By Howard Schneider
WASHINGTON (Reuters) – In the month since Federal Reserve Chairman Jerome Powell took a hard line on inflation, stocks have suffered double-digit losses, cracks have opened in global currency markets, and safer US government debt yields have soared. Its highest levels since the dark days of the financial crisis in nearly a decade and a half.
US central bank officials have been clear, as was Powell in his remarks at the Jackson Hole Economic Conference in Wyoming and following last week’s central bank policy meeting: There is no bailout coming.
If the long-touted “Fed State Bank” – the notable tendency to turn to help financial markets – does not die, it has been put into a deep slumber, with US officials making it clear in recent days that they are looking beyond the sea of red on Wall Street and a collapse of anxiety in The outside is that the US central bank could push the world to the brink of recession.
For Chicago Fed President Charles Evans, it was a “sober assessment” of the breadth and persistence of high inflation that prompted him to join the consensus that US interest rates would need to continue to rise aggressively. For hawkish St. Louis Fed President James Bullard, “chaos” is likely if the Fed ignores the 2% inflation target that outweighs concern about any immediate risks from aggressive Fed tightening.
Across the Fed’s opinion spectrum, the reasons may vary, but the conclusion is the same. Higher interest rates are coming, and they are likely to stay in place for a long time.
Matthew Luzzetti, chief US economist at German Bank (ETR :).
Despite volatility in global markets and warnings from international officials about the impact of US monetary policy on the rest of the world, Fed officials “are reluctant, and I rightly think so, to say they are either worried or worried, or that this affects policy,” Luzzetti said. .
financial market stagnation
As if to underscore the point, Tuesday hit a new low in nearly two years in a bear market that has traders hanging squarely on the Federal Reserve. The index is down about 14% in the roughly five weeks since Powell spoke in Wyoming, while the two-year US Treasury yield has risen from 3.3% to about 4.2%.
2022 Stock Market Value Loss: https://graphics.reuters.com/USA-FED/MARKETS/lbvgnqnzjpq/chart.png
“The Fed has de-traded,” said Charles Lemonides, founder of the hedge fund. “If the economy doesn’t roll around and dies and unemployment doesn’t spread, it becomes more of a financial market slump than a Main Street slump.” ValueWorks LLC. “People are not losing their jobs, but investors are down 20% in any existing asset class.”
The Federal Reserve raised interest rates last week by three-quarters of a percentage point, the third consecutive increase of this size. The central bank’s policy rate is now 3 percentage points higher than where it began the year, and policymakers have indicated it will rise another 1.25 percentage points by January in the fastest tightening of policy in decades.
The goal is to cool inflation running more than three times the Fed’s 2% target by its preferred metric, and policymakers say they are not inclined to hold back price increases until inflation heads clearly lower.
In other words, it won’t be a stock market crash that’s driving the Fed into a “pivot” policy, but several months of data showing that the backside of inflation has been broken.
Some analysts worry that the Fed’s policy decisions are now ahead of its ability to assess the impact on the economy from interest rate hikes that have already been achieved, and cite market pressures and volatility as evidence that it may have overtaken.
This argument has not yet been found in the Fed.
“I don’t like that monetary policy is built on equities too much,” Bullard said at an economic forum in London on Tuesday. “Stocks are very volatile…part of it is a natural repricing of the value of some of these institutional entities and that would be the right response for the markets to the idea that we have higher interest rates.”
‘Reset’ is in progress
To some extent, in fact, the impetus for Fed policy is to force such a reassessment. Far from the Federal Reserve “setting a floor” for financial markets, one of the ways a central bank can slow demand and inflation is through wealth effects – the effect of purchasing power stored in real estate, stocks, and other assets on actual spending, or in this case a loss of wealth Which may cause some families to decline.
According to one indicator held by the Chicago Fed, public financial conditions remain below their historical average, or slightly on the “loose” side, a sign that Fed officials may still have, as many of them described it, “the work to be done.” They have to do it.”
Higher interest rates paid on safe investments such as short-term US Treasuries aid in this effort by changing the prices of a wide range of other assets. In the current environment, with the Fed spearheading a global tightening, it has also driven up the dollar to the point where it has shaken FX markets, investors and central banks dealing in dollar-denominated commodities or financial instruments.
Stocks and bonds fell. The dollar rose: https://graphics.reuters.com/USA-FED/MARKETS/zdpxologzvx/chart.png
Federal Reserve officials have never accepted the argument that interest rate or other policy decisions are intended to support financial markets beyond ensuring that those markets retain sufficient public confidence to operate, as they have done with liquidity and other means of support during the COVID-19 pandemic.
Far from encouraging any notion that they would back off, the same officials who once advocated keeping interest rates “lower for longer” to encourage employment are now heralding a “longer high for longer” inflation fix.
How long that takes, and whether it will be followed by rates that regress to the low levels seen as a key component of the global economy before the pandemic, or remain unexpectedly higher, could reshape financial markets around the world.
“There is some form of reset going on,” said Gregory Daco, chief economist at EY-Parthenon. “I’m not going to pretend to understand all the basic dynamics and what fermentation is.”