**The Fed Wants to Raise Rates Quickly, but May Not Know Where to Stop**
**Elevated inflation poses a new challenge in divining the ‘neutral’ rate that neither spurs nor slows growth**
**By Nick Timiraos, The Wall Street Journal, April 24, 2022**
**Federal Reserve Chairman Jerome Powell is shifting monetary tightening into a higher gear. His goal sounds straightforward—lift interest rates to “neutral,” a setting that neither spurs nor slows growth....**
**At their meeting next month, officials are set to approve plans to shrink their $9 trillion asset portfolio and to raise their benchmark rate by a half percentage point. They are poised to follow with another half-point in June....**
**The nominal neutral rate is arrived at by adding inflation to the inflation-adjusted or real neutral rate. It is real, not nominal, rates that matter for monetary policy. Because inflation reduces the burden of paying back debt, a positive real rate is necessary to create an incentive to save and a disincentive to borrow, such as for a home or business, thereby slowing economic growth and cooling inflation pressure....** [end quote]
Uh-oh. The March 2022 12-month inflation rate was 8.5%.
The Fed was hoping for a “neutral” fed funds rate of 2.5% but that’s actually a negative rate of -6%. Treasury real yields are negative at all durations.
This puts the Fed in a bind. It puts Treasury bond owners behind the 8 ball for $Trillions of low-yield bonds issued in the past few years. When rates go up, the value of those bonds will drop. But if the Fed keeps rates negative, inflation will continue.
Rising yields causes the stock market to drop, partly because new borrowing for consumers and businesses will be more expensive and partly because some investors will shift their money from stocks to higher-yielding bonds.
The last high of the SPX was Jan. 3, 2022. That was 77 trading days ago. I’m keeping an eye out for the “mungofitch 99 day rule” since I think there are many Macroeconomic reasons for the market to continue to drop and few to turn it to the positive. These reasons include rising interest rates, continuing high inflation, continuing supply chain issues, sanctions on Russia, rising Covid and the election cycle (mid-term election year).
The stock indexes, which bounced a little, are headed back down, along with internals such as VIX.
Interest rates are relentlessly climbing at all durations. The entire Treasury yield curve is rising. The 10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity (T10Y2Y) has bounced up and is slightly positive. Junk bonds are not falling faster than the Treasuries.
The 30 year mortgage rate is over 5% and still rising.
The Fear & Greed Index is in Fear, though not extreme. The trade is risk-off. Although bond prices are falling, stock prices are falling even faster. USD and gold are rising. Oil and natgas fell back a little last week from their relentless climb.
Federal Reserve actions are meant to reduce inflation, but their effect is more direct on assets than on consumer prices. The assets that are most interest-rate sensitive, including stocks of highly-indebted companies with inadequate free cash flow, are most vulnerable.
The METAR for next week is gloomy weather, similar to last week. Not a storm, but gradual deflation of asset prices…unless the bubble is burst by an unexpected problem.