WASHINGTON, Sept 28 (Reuters) – In the month since Federal Reserve Chair Jerome Powell set a hard line for inflation, stocks have suffered double-digit losses, chasms have opened up in global currency markets and yields in the safest US – Treasury bonds have managed to climb to their highest level since the dark days of the financial crisis almost a decade and a half ago.
However, Federal Reserve officials have made it clear, just as Powell did in his remarks at the Jackson Hole economic conference in Wyoming and after last week’s central bank monetary policy meeting: no bailout is coming.
If the long-heralded “Fed put” — a perceived trend to bail out financial markets — is not dead, it has been put into a deep hibernation, with US officials making it clear in recent days that they are over the sea Looking Out Red on Wall Street and the avalanche of concern overseas that the Federal Reserve could push the world to the brink of recession.
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For the normally dovish Chicago Fed Chairman Charles Evans, it was a “sobering assessment” of the breadth and persistence of high inflation that prompted him to join the consensus that US interest rates must continue to rise aggressively. For dovish St. Louis Fed Chairman James Bullard, it is the potential for “chaos” if the Fed ignores its 2% inflation target that outweighs concerns about immediate risks from the Fed’s aggressive tightening.
Across the Fed’s spectrum of opinion, the reasons may differ, but the conclusion is the same. Higher interest rates are coming and likely to remain so for a long time to come.
“What we’ve heard from the Fed simply won’t allow for any moderate opening in their communications until financial conditions have reached a much tighter level and there is compelling evidence that inflation is coming down,” said Matthew Luzzetti, US chief economist at of Deutsche Bank Bank.
Despite volatility in global markets and warnings from international officials about the impact of US monetary policy on the rest of the world, “Fed officials are reluctant, and I think rightly so, to say that they are either concerned or concerned, or that it is having an impact politics,” said Luzzetti.
“FINANCIAL MARKET RECESSION”
As if to emphasize the point, the S&P 500 Index (.SPX) hit a fresh nearly two-year low on Tuesday in a bear market that traders are pinning squarely on the Fed. The index is down about 14% in the nearly five weeks since Powell spoke in Wyoming, while the US 2-year Treasury yield has risen to about 4.2% from 3.3%.
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“The Fed put is off the table. Unless the economy topples and dies and unemployment doesn’t rise, it will be more of a financial markets recession than a Main Street recession,” said Charles Lemonides, founder of hedge fund ValueWorks LLC. “People aren’t losing their jobs, but investors are down 20% in every asset class there is.”
The Fed raised interest rates by three-quarters of a percentage point last week, the third straight hike of this magnitude. The central bank’s interest rate is now 3 percentage points higher than at the start of the year and policymakers have indicated it will rise another 1.25 percentage points by January, marking the fastest monetary tightening in decades. Continue reading
The goal is to cool inflation, which is more than three times the Fed’s 2% target through its preferred measure, and policymakers say they have no inclination to hold off on rate hikes until inflation is clearly on the downside tends.
In other words, it won’t be a crater in stock markets that will propel the Fed toward a policy pivot, but rather data over several months showing that the spine of inflation has been broken.
Some analysts worry that the Fed’s policy decisions are now ahead of its ability to assess the impact on the economy of the hikes it has already made, citing market stress and volatility as evidence it may have gone too far.
This argument has not yet found a place at the Fed.
“I don’t like basing monetary policy so much on equities,” Bullard told an economic forum in London on Tuesday. “Equities are so volatile… Part of it is a natural re-evaluation of the value of some of these business units and that would be the right market reaction to the idea that we have higher interest rates.”
‘RESET’ IN PROGRESS
To some extent, the thrust of Fed policy is to force just such a re-rating. Far from a Fed “put” that sets a floor for financial markets, one way the central bank is trying to curb demand and inflation is through wealth effects — the impact that purchasing power stored in real estate, stocks, and other assets has on actual spending spending, or in this case the loss of wealth, which could lead some households to retire.
According to an index maintained by the Chicago Fed, overall financial conditions remain below their historical average or slightly on the “loose” side, a signal that Fed officials may have “work to do,” as many of them put it.
Rising interest rates paid on safe-haven assets like short-dated US Treasuries are aiding these efforts by shifting the prices of a wide range of other assets. In the current environment, in which the Fed is leading global tightening, it has also boosted the value of the dollar to a degree that has rattled foreign exchange markets, investors and central banks trading dollar-denominated commodities or financial instruments.
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Fed officials have never accepted the argument that their interest rate or other policy decisions are intended to support financial markets, aside from ensuring that those markets retain enough public confidence to function, as they did with liquidity and other backstops during of the COVID-19 pandemic have done.
Far from promoting the idea that they will ease, the same officials who once argued that interest rates should stay “lower longer” to encourage employment are now preaching “higher longer” to freeze inflation .
How long this takes, and whether this is followed by interest rates falling back to the low levels that were a staple of the global economy before the pandemic, or staying higher than expected, could transform financial markets around the world.
“There’s a kind of reset that’s going on,” said Gregory Daco, chief economist at EY-Parthenon. “I wouldn’t pretend to understand all the underlying dynamics and what’s brewing.”
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Reporting by Howard Schneider Additional reporting by David Randall and Lindsay Dunsmuir; Adaptation by Dan Burns and Paul Simao
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Howard Schneider
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