Tag: The Federal Reserve

Taming Inflation - Tough Action Needed

Posted on by Noah Kiedrowski

Curbing Inflation - The Priority

Rolling back inflation is an absolute necessity before these markets can start to turn back this tide of relentless selling. The process of curbing inflation will not be quick, nor will it be an easy feat. A delicate balance must be exercised to curb inflation via rising rates while not destroying the economy.

To curtail these 40-year highs in inflation, the economy will need to slow, demand will need to cool and the supply chain will need time to catch up to come back into balance.

The Federal Reserve will raise short-term interest rates from historic lows near zero as the economy recovered from the pandemic. The Federal Reserve will be looking for lower CPI numbers, softer labor market conditions and resolution of supply chain constraints prior to taking a dovish stance on future rate hikes. The latter will be the confluence of catalysts the market needs to propel higher.

Overall Markets

The overall markets have been under heavy and relentless selling. The average Nasdaq stock has undergone a 50% drop from its high.

The S&P 500 now trades at a level first reached more than 16 months ago in early February 2021. This move negates the post-Covid advance in equities.

The multi-wave corrections that culminated in February 2016 and December 2018 both bottomed at levels first reached nearly two years prior. Thus, these markets are reaching the point where the past two years of appreciation has been erased.

Bank of America’s Bull & Bear Indicator, which captures fund flows and other market-based risk-appetite measures, is well in the fearful depths that typically imply a buying opportunity. During prolonged stressed periods (i.e., 2000-’02 and 2008-’09) bear markets had this gauge persistently stuck at these low levels while prices continued to trend lower.

University of Michigan consumer sentiment poll came in at a level lower than during the global financial crisis and if not revised higher will rank as the bleakest monthly reading since 1978. Extreme negative readings in the University of Michigan poll have served as great inflection points for how stocks perform over the subsequent 12-month period.

Per JPMorgan the S&P 500 has averaged a 25% gain in the year following the eight Michigan sentiment troughs going back 50 years, with the worst return at 14%.

It’s noteworthy to point out that hindsight is 20/20 thus troughs are only known in a look-back analysis after sentiment starts to recover from a low. The markets may be close but may not be at this point yet.

Key Macroeconomic Factors

The Consumer Price Index (CPI) has become the most influential and critical variable in today’s market. The CPI readings directly impact monetary policy put forth by Federal Reserve via interest rate hikes, bond buying and liquidity measures.

Inflation continues to be persistent throughout the economy and the Federal Reserve must balance curtailing inflation without destroying the economy. The impact of inflation is now flowing through to companies and consumers alike. Inflation has reared its ugly head and is now negatively impacting companies’ gross margins and dampening consumer demand due to soaring prices, specifically gasoline.

The confluence of rising interest rates, inflation, China Covid lockdowns and the war in Ukraine has resulted in first half of 2022 overwhelmingly negative. 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 on monetary policy and/or its inability to combat inflation responsibly to engineer an economic “soft landing”.

However, if any of these macroeconomic factors abate (i.e., CPI, China re-opening, Russian/Ukraine conflict and interest rate hikes) this could serve as a launching pad for the markets to stabilize and appreciate higher.

Inflation - 40 Year Highs

Inflation pushed higher in May as prices rose 8.6% from a year ago for the fastest increase in nearly 40 years. Excluding volatile food and energy prices, core CPI was up 6%. Both CPI and core CPI exceeded estimates and came in hotter than expected. Surging costs for shelter, gasoline and food prices all contributed to the increase.

The latest CPI numbers casted doubt that inflation may have peaked and adds to fears that the U.S. economy is nearing a recession.

The CPI report comes at a time when the Federal Reserve is in the early stages of a rate-hiking campaign to slow growth and bring down prices. May’s report likely locks-in multiple 50 basis point interest rate increases ahead. With 75 basis points of rate rises already put in place, markets widely expect the Fed to continue tightening through 2022 and likely into 2023.

Conclusion

Curbing inflation is an absolute necessity for the markets to stabilize and start to reverse the tide of relentless selling. A delicate balance must be exercised to curtail these 40-year highs in inflation.

As a consequence, the economy will need to slow, demand will need to cool and the supply chain will need time to catch up to come back into balance.

The Federal Reserve will be looking for lower CPI numbers, softer labor market conditions and resolution of supply chain constraints prior to taking a dovish stance on future rate hikes. The latter will be the confluence of catalysts the market needs to propel higher.

The Consumer Price Index (CPI) has become the most influential and critical variable in today’s market. The impact of inflation is now flowing through to companies and consumers alike with Target and Walmart issuing profit warnings.

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 on monetary policy and/or its inability to combat inflation responsibly to engineer an economic “soft landing”. It will likely take successive downward CPI readings before rates will stabilize and the markets can appreciate higher.

However, if any of the other macroeconomic factors abate (i.e., China re-opening and Russian/Ukraine conflict) this could serve to accelerate the stabilization of the markets and remove the functional constraints for the markets to appreciate higher.

Noah Kiedrowski
INO.com Contributor

Disclosure: Stock Options Dad LLC is a Registered Investment Adviser (RIA) firm specializing in options-based services and education. There are no business relationships with any companies mentioned in this article. This article reflects the opinions of the RIA. Any recommendation contained in this article is subject to change at any time. No recommendation is intended to constitute an entire portfolio. The author encourages all investors to conduct their own research and due diligence prior to investing or taking any actions in options trading. Please feel free to comment and provide feedback; the author values all responses. The author is the founder and Managing Member of Stock Options Dad LLC – A Registered Investment Adviser (RIA) firm www.stockoptionsdad.com defining risk, leveraging a minimal amount of capital and maximizing return on investment. For more engaging, short-duration options-based content, visit Stock Options Dad LLC’s YouTube channel. Please direct all inquires to

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Is The Powell Put dead? Maybe Not

Posted on by George Yacik

Last week a bevy of Federal Reserve officials led by New York Fed President John Williams, "who is one of the most senior advisers to Chairman Jerome Powell and helps shape the policy agenda," in the words of the Wall Street Journal, tried to talk down the market's concern that the Fed is about to ratchet up interest rates aggressively, starting with a 50-basis point hike at its next meeting March 15-16.

"There's really no kind of compelling argument that you have to be faster right in the beginning" with rate increases, Williams said last Friday. "There's no need to do something 'extra' at the beginning of the process of liftoff. We can…steadily move up interest rates and reassess. I don't feel a need that we'd have to move really fast at the beginning."

The 50 bp talk got started by St. Louis Fed President James Bullard, who had said earlier that "the best response to this situation [meaning the recent surge in inflation to 40-year highs] is to front-load the removal of accommodation." That provoked a large selloff in the stock and bond markets. Subsequently, several Fed officials and regional bank presidents, including Williams, pushed back on that assessment, saying that the Fed would take a more measured approach to raising rates. The desired path now seems to be a 25-bp increase at the March meeting, following which the Fed would see what effect that would have before taking the next step. Continue reading "Is The Powell Put dead? Maybe Not" →

Can A Dove Change Its Spots?

Posted on by George Yacik

Thankfully, there is at least one area of U.S. society where people are still allowed to disagree, and that's on Wall Street, where there is a clear difference of opinion on what we can expect the Fed to do this year regarding raising interest rates to fight inflation. What's surprising is how widely divergent they are.

Let's start with the most aggressive, or hawkish, prediction. That belongs to Bank of America.

"Following the continued hawkish pivot at the January FOMC meeting, we expect the Fed to start tightening at the March 2022 meeting, raising rates by 25 basis points at every remaining meeting this year for a total of seven hikes, and in every quarter of 2023 for a total of four hikes," BofA economists said. That would put the fed funds target rate at a range of 1.75% to 2% by the end of this year and 2.75% to 3.00% by the end of next year when the bank expects the rate-raising cycle to end.

"The Fed has all but admitted that it is seriously behind the curve," the BofA research note added. "When you are behind in a race, you don't take water breaks," it said, explaining its aggressive forecast. Continue reading "Can A Dove Change Its Spots?" →

Failure To launch

Posted on by George Yacik

Can everybody just chill a little? Yes, the Fed is “indicating” it’s moving to a less accommodative stance, no more government bond purchases, higher interest rates, maybe a decrease in its massive $9 trillion balance sheet, but it’s decidedly not going away. It simply can’t. Tightening? Hardly.

Indeed, as the results of its January 25-26 monetary policy meeting show, the Fed is basically being dragged kicking and screaming into stopping its asset purchases and raising interest rates to fight inflation, neither of which it actually announced at the conclusion of the meeting. Rather, it said it would buy “at least” another $20 billion of Treasury securities and $10 billion of mortgage-backed securities before ending the purchases “in early March.” It also didn’t raise interest rates, instead saying, “it will soon be appropriate to raise the target range for the federal funds rate.” Whenever that is, although everyone seems to believe it means its next meeting, which is set for March 15-16 (there’s no meeting in February). But again, the Fed didn’t say that.

If inflation is so darn dangerous to our nation’s economic health, why is the Fed willing to let it run another month or two before it starts acting instead of, to use Jerome Powell’s famous phrase, simply “talking about talking about” it? Continue reading "Failure To launch" →

Rescue Me

Posted on by George Yacik

How transitory is transitory? Maybe inflation won’t turn out to be as “transitory” as we would like, but even the Federal Reserve thinks inflation will ease sometime in the not-too-distant future, likely this year. The bond market certainly doesn’t seem overly concerned about it, with the 10-year Treasury note trading late last week at about 1.75%, or about six percentage points below the current inflation rate. If inflation is such a big problem that must be addressed immediately, shouldn’t long-term bond rates be closer to 5% or 6% rather than less than 2%?

Then why is the Fed all of a sudden so worried about stamping out inflation when it’s also predicting that the inflation rate will come down fairly soon? What’s the rush?

According to its most recent economic projections released after its December 15 monetary policy meeting, the Fed said it expected inflation to fall to 2.6% this year, from 5.3% last year, then fall to 2.3% next year and 2.1% in 2024. Yet now the Fed can’t seem to stamp out inflation fast enough, even though it was Fed policy not too long ago to let inflation “burn hotter for longer.” What happened with that? Continue reading "Rescue Me" →