Control Panel: Fed will continue tightening

Investment Analysis Clubs Macro Economic Trends and Risks
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The Fed has repeated many times that it will continue tightening until PCE inflation recedes to their target of 2%. Fed Chair Powell has said that this will cause “pain,” which most interpret as meaning a recession.

The linked Bridgewater article shows data indicating that stocks have declined only to the extent that is caused by rising interest rates. Stocks have not yet priced in the expected drop from a recession. This is an excellent article which clearly explains that tightening will take a long time and that the markets (stock and bond) have much further to fall.

The rising USD is making it hard for multinational companies to compete in foreign markets and also reducing the USD values of profits made in foreign currencies.

Lower profits and anticipation of a recession are not good for stock prices.

Rising interest rates are also bad for bond values. The standard 60/40 portfolio is falling as both stocks and bonds are dropping at the same time. This is rare. It’s the worst drop since 1980.

Markets Are Topsy-Turvy, and There’s Worse: It’s Hard to Cushion Your Portfolio

Stocks and bonds are going down together—in a way they haven’t for years

By James Mackintosh

The Wall Street Journal, Oct. 9, 2022
…
I expect continued upward pressure on inflation, meaning higher rates are required to meet the Fed’s 2% target and the stock-bond link will be more like the 1970s and 1980s. Workers have gained political power, governments are more willing to run big deficits, deglobalization and outright protectionism have reduced cross-border trade and efficiency, and there won’t be a repeat of the shock of hundreds of millions of Chinese workers suddenly competing in the world economy…[end quote]

The whining and screaming about the Fed needing to stop their tightening has already begun. Rear view mirror and all that. But Fed Chair Powell is very aware of the resurgence of inflation in the 1970s when Fed Chair Arthur Burns listened to those pressures. Powell wants to be Volcker, not Burns. The Fed will continue tightening.

The markets still don’t grok this because many of the traders can’t remember a time without a Fed put. But I think that this time Powell is supported by the rest of the FOMC.

The Control Panel shows that all trends are continuing. Both stock and bond prices are falling, but the SPX is falling faster than the 10YT.

The Fear & Greed Index is in Extreme Fear but not bottomed out. The Treasury yield curve is still rising and is inverted along its entire maturity except for the fed funds rate. It will be fully inverted once the fed funds rate climbs above 3.5% as expected by the end of 2022.

Financial stress has risen to the level of 2016 but not to crisis levels. Ditto junk bond spreads.

The METAR is for autumn weather, cool and rainy. The Fed is clear that they will be pushing the Macro economy into winter but it’s not there yet. All signals are deteriorating but there is no sign of panic or revulsion…yet.

I am buying 6 to 9 month Treasuries and mortgage bonds on the secondary market to hold to maturity for a safe yield.

Wendy

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Wendy,

I have seen Fed folk saying they will tighten until inflation is projected or on trend to go to 2%.

I have seen Fed folk saying rates will need ‘to remain high’ until inflation is 2%.

But I don’t recall any of them saying they would tighten until inflation is 2%. Perhaps I have missed something. Do you have a source for this?

For example:

https://www.bloomberg.com/news/articles/2022-06-01/fed-s-daly-comfortable-raising-rates-until-inflation-tamed

“The Federal Reserve should tighten policy until inflation begins trending down toward its 2% goal, San Francisco Federal Reserve Bank President Mary Daly said”

https://www.reuters.com/article/usa-fed-barkin-idUKKBN2Q80FO

“The U.S. Federal Reserve must lift interest rates to a level that restrains economic activity and keep them there until policymakers are “convinced” that inflation is subsiding, Richmond Fed President Thomas Barkin told the Financial Times on Tuesday.”

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I think the rates will continue to go up but the impact is elsewhere.

The IRA matters more to inflation.

The FED’s rate hikes are dramatically dropping asset prices.

The fiscal policy will drop spending in the top bracket where most of the inflation is either created or developed.

Corporate tax hikes will make corporate planners decide how to make their companies more productive. This is expansive longer term. The bigger payday for corporations is in economies of scale, productivity and a growing middle class consumer base.

All that is really happening is a normalization of conditions. Owning equities rising into the top of last year’s market was a mistake for many in our generation. Using that mistake as the paradigm for viewing the current events is unworkable, it is not a full enough truth. Largess is not a given.

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Fed Chair Powell announced the 2% goal. I already posted this link once today. Google it yourself.
Wendy

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I was also trying to compare what was posted versus what the Fed said (Fed's estimate of current, forward inflation < 4.5%, roughly - #10 by mostlylong). Here’s what I found.

A METAR posted:

I interpreted the METAR post as:
The Fed will monitor PCE inflation to check if it is near 2% for several months and then the Fed may adjust policy based on this.
The Fed or Powell said:
p. 5 “…we’ll need to bring our funds rate to a restrictive level and to keep it there for some time.”
p. 5 “ultimately we’ll want to see clear evidence that inflation is moving back down to 2 percent.”
p. 5 “In terms of reducing rates, I think we’d want to be very confident that inflation is moving back down to 2 percent before we would consider that.”
I see nothing so specific on level and timing as around 2% for several months. The Fed seems more focused on the trend towards 2% and they won’t commit to any time schedule.

A METAR posted:

I interpreted the METAR post as:
Not sure what this sentence is trying to say, something about the Fed and estimates of forward inflation rate.
The Fed or Powell said:
Powell uses the word forward several times in the context of forward real rates, but I’m not sure how to line those comments up with the post above.

A METAR posted:

I (and I believe luxmain also) interpreted the METAR post as:
The Fed will increase the Fed funds rate until PCE inflation is 2%.
The Fed or Powell said:
p. 5 “…we’ll need to bring our funds rate to a restrictive level and to keep it there for some time.”
p. 5 “ultimately we’ll want to see clear evidence that inflation is moving back down to 2 percent.”
p. 5 “In terms of reducing rates, I think we’d want to be very confident that inflation is moving back down to 2 percent before we would consider that.”
I see nothing saying the Fed will keep increasing rates, or tighten, until PCE inflation is 2%.

Maybe I am just being very particular in parsing words and other METARs are more casual.

Fed Press Conference Transcript

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To me the biggest question is whether they are looking at annual inflation (which won’t some down for many months since it’s historical) or monthly inflation which is already around zero recently …

The answer though is likely that they look at many factors, not just inflation, and the present jobs situation is not conducive to zero inflation …

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Public Finance on the 300 level teaches that the inflation can be brought down by fiscal policies. That takes months. There was the enactment of the IRA but the new tax rates need time to be instituted and to matter. I believe some aspects of the act are in affect now. Most of it starts off in 2023.

Fiscal policy has a greater lag time than monetary policy.

Although the UK messed up so bad some days ago that it was an instantaneous blowout.

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While there is no politics allowed on Metar, it is allowed in the ambient environment. As Bill Clinton famously said “It’s all about the economy, stupid” (or something to that effect), it is important to realize that, within the next quarter, we will be entering the presidential campaign season. The party in power is always blamed for the state of the economy (whether they were responsible for its actions or not) and there is a limited time window for either the current inflationary environment coupled with likely recession to be resolved, or else the opposing 'base" voting on a distorted/filtered information set for a replacement set of culprits - with all the likely changes in direction that would imply.

The above statement is not designed to start even a hint of political debate, but simply remind us that this is a three (or more) dimensional environment with many variables.

Jeff

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Jeff,

Did you see the deficit reduction numbers because tax revenues are way up?

We can go back to supply side econ. The UK did that two weeks ago. We can use 40% of American citizens. We can widen our trade deficits. We can create massive federal deficits again tell lies about welfare causing that instead of crap decisions at the top. We can make the country poorer. All true economic decisions within our power.

Should we mess up our economy? It would satisfy those who know nothing much about economics but need to have extreme control of our economy.

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Wendy,
You left out one significant consequence of the Fed’s policy on Treasuries. As U.S. Treasury securities rise, so too will the federal government’s borrowing costs. The Congressional Budget Office (CBO) projected that annual net interest costs would total $399 billion in 2022( https://www.cbo.gov/publication/57950) and nearly triple over the upcoming decade, soaring from $442 billion to $1.2 trillion and summing to $8.1 trillion over that period.
As can been understood by your link
Dynamic Yield Curve | Free Charts | StockCharts.com

CBO Report:

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How right you are, TucsonBones! I remember a time at the end of the 1970s when about 1/4 of the U.S. budget went to paying interest on the national debt.

One reason to smack down inflation NOW is that the interest rate on longer-term Treasury bonds will rise if bond traders believe that inflation will stay high for the long term. The Fed’s current policy to raise the fed funds rate now (resulting in a slight rise in Treasury bond yields) is like nasty chemotherapy to treat a potentially fatal cancer.

Wendy

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