Why a Strong Economy Is Making Stock Investors Jittery
After stocks jumped more than 6 percent in January, the tone shifted markedly this week as a steady flow of data showed the economy continued to run hot.
By Joe Rennison and Jeanna Smialek, The New York Times, Feb. 17, 2023
It’s dawning on stock investors that they were wrong about the Federal Reserve…
The economy retains significant vigor. The Fed has repeatedly warned that there is more work to do to slow rising prices, even after a year of rapid policy adjustments that were meant to cool down the economy. Now, the continued momentum has undercut some investors’ hopes that inflation would steadily resume the slowdown it began toward the end of last year and allow the central bank to end its rate increases earlier than it had communicated…
John C. Williams, president of the powerful Federal Reserve Bank of New York, suggested this week that rates were likely to rise to a range of 5 to 5.5 percent — slightly above the 5 to 5.25 percent median in the central bank’s December forecast. He and several of his colleagues have said they may need to do even more than that if consumption and the labor market remain so robust…[end quote]
The stock market has been buoyed by animal spirits and the confidence that the Fed will back off despite their transparency about Fed plans.
Be careful out there. METARs of a certain age remember when a fed funds rate of 2% above inflation was considered normal, not restrictive. Even with the permissive Fed of the past 20 years, a fed funds rate of 5% will be no surprise and the Fed will hold it until inflation falls and maintains at its target of 2% for an extended time.
The Uneasy Dance Between the Markets and the Fed
Exuberance in financial markets is likely to only strengthen the Federal Reserve’s resolve and shake up those very markets, our columnist says.
By Jeff Sommer, The New York Times, Feb. 17, 2023
…
Two sets of measurements suggest what has been happening [in the bond market that worries the Fed]. First, a project at the Federal Reserve Bank of Chicago, which uses more than 100 indicators to come up with a National Financial Conditions Index for the overall economy, shows that financial conditions tightened — as the Fed wanted — through October. But even though the central bank persisted in raising the federal funds rate, conditions loosened through the latest reading of the index on Feb. 10.
Second, the Federal Reserve Bank of San Francisco’s Proxy Funds Rate — which uses an array of data to assess broader financial conditions on a monthly basis — shows a tightening of financial conditions through November, followed by a loosening in January and February. [end quote]
The “array” of data is far more extensive than the fed funds rate and Treasury yield curve. It includes corporate bonds used to finance companies, mortgage rates, credit card interest, etc.
The Fed isn’t happy that overall financial conditions are loosening despite its increases in the fed funds rate. This may cause the Fed to crank up the fed funds rate plus maybe more QT.
The proxy rate can be interpreted as indicating what federal funds rate would typically be associated with prevailing financial market conditions if these conditions were driven solely by the funds rate. The proxy rate is currently over 6% while the fed funds rate is below 5%. If the economy doesn’t cool down the Fed may raise the fed funds rate to 6% if that’s the only tool they use.
That will impact the stock as well as bond markets.
Wendy