Wishful Thinking

Relax, folks. There isn't going to be a long recession, if there is one at all, and you're probably not going to lose your job, and inflation will be down below 3% by next year. The Fed’s got your back.

That's the story from the Federal Reserve’s incredibly optimistic projections released after the end of Wednesday's interest rate-setting meeting. I use the word “incredibly” deliberately, because these projections seem anything but credible. But we can hope.

Somewhat lost in the release of the Fed's 75 basis-point hike in the federal funds rate last Wednesday is that U.S. GDP growth will remain fairly positive this year, next year, and into 2024, according to the Fed’s latest projections.

The Fed now forecasts U.S. GDP will grow by 1.7% this year as well as in 2023, rising to 1.9% in 2024. Now those are down from the Fed’s March projections, to be sure, but they still remain above recessionary (i.e., negative) levels.

Likewise, the Fed is projecting that the unemployment rate will end this year at 3.7% and 3.9% next year, before rising to 4.1% in 2024. Again, those are worse than the March projections but not overly so, considering all the scare talk about how the Fed’s newly hawkish rate-rising policy will inevitably cause a recession and a jump in unemployment.

Meanwhile the Fed is also projecting that the PCE inflation rate will end 2022 at 5.2% before dropping in half to 2.6% next year and to 2.3% in 2024, again higher than its March projections but dramatically lower than where we are today at more than 8%.

How does the Fed plan to manage all this, you ask? It sees the fed funds rate reaching 3.4% by the end of this year and 3.8% in 2022, again above its March projections but a lot lower than what you would have expected, given that the yield on the two-year Treasury note is already well above 3%.

In other words, the Fed is merely playing catch-up to where the market has already been for a while.

All in all, I would say, a pretty positive story, a lot better than what we had been expecting. But how much of it can be believed? What the Fed is telling us is that it believes it can really engineer a soft landing, meaning only a moderate rise in the unemployment rate and no recession, at the cost of just slightly higher interest rates, at least compared to today’s inflation rate and current bond market rates.

In other words, the Fed says it can tame inflation back down to less than 3% all while leaving interest rates five percentage points below the current 8% inflation rate. Is that possible?

Meanwhile, what is President Biden doing for his part in trying to drive down inflation? Other than not interfering with Fed policy, which he claims is basically all he can do, he is blaming oil executives for the high price of gasoline.

Short of charging them with getting in bed with Vladimir Putin, he's laying the blame for high energy prices on their failure to explore and drill for oil, leaving out his administration's role in basically forbidding them to do just that and putting pressure, through the Fed and other means, not to lend them money in order for them to do so.

You would think Biden would have been happy that they are not drilling for oil, contributing as they are to the blissful carbon-free future he imagines. But he seems to believe he can have it both ways, namely no new oil production and low gas prices. But I guess that’s the same type of logic the Fed is using in trying to convince us it can whip inflation with a few interest rate hikes with little harm to the overall economy.

The market reaction to all this was fairly predictable. Right after the Fed rate announcement was greeted with euphoria on Wednesday, people woke up the next morning and said, “Hey, wait a minute. This can't possibly be true,” and the selling resumed with renewed fervor.

And why not? Can we take any comfort in what the Fed and our government are telling us, which is that after a dozen years of easy money, quantitative easing, artificially low interest rates, and massive fiscal and monetary stimulus, they can undo all that in a year or so without anyone being inconvenienced?

If only it worked that easily. If Powell wanted to be honest, he could have said, “Folks, there will be a lot of pain over the next couple of years to undo all we have done over the past decade, so brace yourselves for it.”

But people don’t want to hear that, especially in an election year. Although the market seems to know better.

Visit back to read my next article!

George Yacik
INO.com Contributor

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.

Is the Fed Put Kaput?

For those new to the game, the "Fed put" is a belief among investors that the Federal Reserve will come to the rescue anytime the stock market drops a certain amount. While much of the belief in the Fed Put is based on wishful thinking, it has proven to be the case enough times over the past 35 years or so that many investors have come to expect it.

Belief in the Fed put dates back to former Fed chair Alan Greenspan, who lowered interest rates and eased monetary policy numerous times during market turmoil, starting with the 1987 stock market crash. Since then, all his successors have followed the same basic policy, from Ben Bernanke to Janet Yellen to Jerome Powell, from the 2001 terrorist attacks to the 2008 global financial crisis to the 2020 coronavirus outbreak.

Of course, nearly all of those examples of the Fed put occurred during periods of benign inflation, when the Fed felt safe lowering interest rates to zero and injecting enormous amounts of money into the economy without fear of igniting price increases. Now, however, we live in a world of 8% inflation, and the Powell Fed has stated quite clearly that battling inflation is Priority No. 1, practically its only mission at the moment.

Indeed, when the S&P 500 fell 18% between reaching its all-time high of 4766 on December 27 through the recent low of 3901 on May 16 (the plunge in NASDAQ was even worse), the Fed sat on its hands, indicating the put is no longer suitable in this environment.

But since then (as of June 8) the S&P has rallied more than 6%. Is that a sign that some market watchers believe the Fed is once again going to exercise its put, or was it merely a dead cat bounce or buying the dip (or whatever you want to call it) on the road to even lower stock prices? Continue reading "Is the Fed Put Kaput?"

The Fed Giveth, The Fed Taketh Away

With the stock market tanking and the Federal Reserve finally starting to raise interest rates and reduce its $9 trillion balance sheet, it's probably a good time to look back and determine how much of the stock market's gains in the past 12 years or so have been built on extremely accommodative Fed monetary policy. That could provide some idea of how much we can expect the market to drop once the Fed has finally stopped the tightening process, and when stocks might start rising again.

Since reaching its all-time high of 16,057 back on November 15, the NASDAQ had dropped nearly 29% as of May 18, when it closed at 11,418. Likewise, the S&P 500 is down nearly 18% since it hit its all-time high on December 27, while the Dow is off more than 13% after reaching its peak on that same day.

Those declines followed several indications from Fed Chair Jerome Powell and other Fed officials that the central bank had finally conceded that inflation wasn't "transitory" after all and that it had to act aggressively before inflation got totally out of control.

The Fed raised its benchmark interest rate by 25 basis points on March 16, its first rate increase since December 2018, and another 50 bps on May 4, its largest increase since May 2000. The Fed's next meeting is scheduled for the middle of next month, at which it is expected to vote for another 50-bp hike, followed by several more by the end of the year. If the Fed raises rates by 50 bps at each of its next five meetings, including the one right before Election Day, that will push its benchmark rate to Continue reading "The Fed Giveth, The Fed Taketh Away"

Signs Of Peaking Inflation?

Inflation – The Stock Market Achilles Heel

The stock market is a forecasting instrument that anticipates and prices-in future economic conditions. The confluence of rising interest rates, inflation, China Covid lockdowns, and the war in Ukraine has resulted in months of selling. The relentless, indiscriminate selling has pushed the Dow Jones and S&P 500 deep into correction territory while pushing the Nasdaq deep into a bear market. As such, the market appears to be factoring in a worst-case scenario that may result in a Federal Reserve induced recession as a function of over-tightening of monetary policy and/or its inability to combat inflation responsibly for an economic “soft landing.”

The markets are anticipating sequential rate hikes through 2023; however, if inflation has peaked and the tightening cycle turns dovish, then the markets will likely turn the tide on this relentless selling. If inflation has peaked and yields stabilize, these oversold conditions could easily reverse course. For April, market conditions have not been this bad for the Nasdaq and S&P 500 since the Financial Crisis and the Covid 2020 lows, respectively. With signs of inflation peaking, the markets may have fully priced in a worst-case scenario for an inflection point from these oversold conditions. During Federal Reserve tightening cycles, markets typically generate positive returns with an average of a 6.6% return over the tightening period (Figure 1).

Inflation
Figure 1 – Market performance during periods of Federal Reserve tightening cycles

Signs Of Peaking Inflation

There are many areas of the economy where inflation is receding or has peaked. Although energy prices remain elevated due to the Russia-Ukraine conflict, other commodities and inputs into the CPI composite that contribute to inflation are falling. There have been pullbacks in used car sales, easing supply chains (China’s Covid lockdowns are prolonging the supply chain recovery), copper, steel, grain, soy, freight, lumber, and aluminum prices. Continue reading "Signs Of Peaking Inflation?"

Let's Get Serious

Federal Reserve Chair Jerome Powell indicated strongly last week that the Fed will likely raise interest rates by 50 basis points at its next meeting on May 3-4. It will likely get more aggressive in its fight against 8%-plus inflation. It’s going to have to because just as fast as the Fed is trying to bail water out of the boat, the White House and Congress are determined to keep pouring it in.

“It is appropriate in my view to be moving a little more quickly” to raise rates than the Fed has recently, Powell said last Thursday at an International Monetary Fund event. “Fifty basis points will be on the table for the May meeting,” he said. That would double the 25-basis point increase at its March meeting, which now looks relatively puny compared to the yield on the 10-year Treasury, which is rapidly approaching a three-handle for the first time since 2018.

St. Louis Fed president James Bullard, suddenly the most hawkish voting member on the Fed’s monetary policy committee, said he thinks a 75-basis point hike is more appropriate. However, he conceded that “more than 50 basis points is not my base case at this point.” Still, 50 bps is a lot better than 25 bps in bringing the Fed’s target closer to the so-called neutral rate, which is when Fed policy is neither accommodative nor restrictive, and the Fed is nowhere near that (although no one really knows what the magic number is). With six more meetings to go this year, including May’s, 50 bps at each meeting would push the fed funds rate above 3%.

That seems awfully aggressive, given the Powell Fed’s generally dovish inclinations. Still, it may have no choice given that Continue reading "Let's Get Serious"