August 8, 2022

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What if the markets are misreading the Fed

2 min read

Stocks surged after last week’s Federal Reserve meeting as some experts argued that the central bank effectively “pivoted” its tone from being uber hawkish about monetary policy to being a bit dovish.

If this interpretation is true, then this could be very bullish as there may be a more clear end in sight for the Fed-sponsored market beatings.

The unfortunate irony, however, is that a market rally reflects easing financial conditions during a time when the Fed is actively trying to tighten financial conditions in its effort to bring inflation down.

In other words, we’re in a period where it’s the markets versus the Fed. And in this battle, there are no winners. A market rally risks stimulating economic growth and fanning inflation, which is bad. On the other hand, an effective Fed means financial market and economic deterioration, which is also bad. It’s a hell of an economic quandary where good news is bad news.

“The fact that the Fed hiked 75 basis points and financial conditions have eased is a problem,” Neil Dutta, head of U.S. economics at Renaissance Macro Research, wrote in an email on Wednesday. “Looser financial conditions make the Fed’s objectives more difficult to achieve. Pricing in cuts after you have hiked undoes the efficacy of hikes in the first place.“

The market’s current enthusiasm for something that may come months from now is the exact opposite of what the Fed needs right now, and it may force the central bank to react aggressively.

“If financial markets get over their skis and start pricing in a rapid move towards less hawkish policy, the FOMC may feel a need to ramp up the pressure once again or at least hold off less,” Bespoke Investment Group analysts wrote on Wednesday.

With that in mind, let’s take a closer look at the events of the past week.

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