Words from the Fed can be hurtful

Stocks lost ground for another session, still heartbroken over Powell’s comments from last Friday. Mortgage rates took the opportunity to rise, mashing on the brake pedal for the slowing-but-still-hot housing market.

I offer you this: NOTHING. What a great quote from a great movie. Jerome Powell was surely inspired by that iconic line last Friday as hopeful investors lined up expecting support from their once close ally. And what they got was…indeed, nothing. Nothing but a bunch of tough talk. Mind you, the Chairman didn’t specify how much and when rates were going up, but rather he said something to the effect of “don’t expect us Fedheads to be soft on inflation, we are tough, and you can take that to the bank.” Um, we already knew that…at least most of us did. Even so, that didn’t stop risk assets from plunging in the minutes and hours after Powell’s speech. Turning back the clock to the cool, cool December of 2018, when a cold was still just a cold and stocks were on the slide as corporate earnings growth was quickly fading and the US economy was gasping for air. The very same Jerome Powell made a different offer. He offered his sincere apologies, a change of heart, and the possibility of easier Fed policy. His words gave markets the much-needed salve to stop falling and begin to climb once again. I have covered this on numerous occasions, but it bears review. The Fed knows that a falling stock market affects consumer confidence, even if consumers don’t own stocks. It’s true. Though “helping bull markets rage” is nowhere to be found in the Fed’s dual mandate, consumer confidence is…implied, at least. Consumer confidence is critical to maintain economic growth as consumption makes up more than 2/3 of GDP growth. So, yes, a rallying stock market has benefits beyond your 401k. Knowing this, you may be wondering “why then, would Powell say something that would clearly upset the stock market, does he want stocks to go down?” Sadly, the short answer may be “yes”.

There is really only one way to curb demand-pull inflation: cause consumers to stop shopping and bidding prices up on everything. Hiking interest rates makes consumption more costly, actually accentuating inflation. With costs of financing already-expensive high-ticket items going up, consumers will ultimately relent and forego their purchases. The unfortunate side effect of that is slower economic growth, and Powell acknowledged in his speech, that slower growth may be necessary to achieve lower inflation. The bond markets have accepted this reality as is evidenced by the rare, inverted yield curve. Stocks, on the other hand, are unique in that their prices reflect performance in the near and far future…beyond this inflationary period. If traders believe that the Fed is going to stop raising rates in the near future, its onward and upward. In contrast, if the Fed is expected to keep raising rates beyond the near-term, all bets are off. How can stock investors gauge what the Fed will be doing in the future? Well, the Fed can tell us, or signal to us with body language. If Fed governors appear concerned about the economy and talk softly, investors will think that rates will level off in the near future. That may be good for stocks but bad for inflation. If the Fed looks tough, it may be good for inflation…but bad for stocks. Beyond the reality of rising rates and borrowing costs, it really is all about the Fed influencing, as best as possible, consumers to do its bidding. Right now, you are probably thinking “with all of this verbal manipulation, what is even real at this point?” Short-term interest rates are higher by around 2 ½ percentage points since last year. Thirty-year fixed mortgage rates are pushing 5% after resting just above 3% in 2021. The stock markets are lower than they were prior to the Fed’s tightening campaign. Fed Funds futures predict that the Fed Funds rate will get as high as 3.82% (about 1.5 percentage points higher than today) by next March…before the Fed starts cutting, yes cutting rates. Last but not least, consumer confidence is faltering. By just how much, we will find out this morning at 10:00 AM Wall Street Time, when the Conference Board releases its monthly number. We know that the state of the stock market will have an impact on that number. Don’t throw in the towel on your friendship with the Fed just yet, it will come back around, and you will be thankful, once again, for its companionship…at some point.

YESTERDAY’S MARKETS

Stocks fell yesterday as speculation of a hardline Fed persisted. The S&P500 traded lower by -0.67%, the Dow Jones Industrial Average fell by -0.57%, the Nasdaq Composite slipped by -1.02%, and the Russell 2000 Index declined by -0.89%. Bonds fell and 10-year Treasury Note yields gained +6 basis points to 3.10%. Cryptos pulled back by -2.05% and Bitcoin traded higher by +0.94%.

NXT UP

• FHFA House Price Index (June) is expected to have climbed by +0.8% after gaining +1.4% in the prior month.
• Conference Board Consumer Confidence (August) may have increased to 98.0 from 95.7.
• JOLTS Job Openings (July) is expected to have declined to 10.375 million from 10.698 million.
• After the closing bell earnings: Crowdstrike, ChargePoint, HP Inc, and Chewy.