The Fed tightens, but does not hang. What happens is that monetary policy operates with a lag. To be understood well: with lagged effects on the real economy, but instantaneous effects on the financial markets, which are very flexible clay. And, this time, the communication clearly anticipated its intentions and the markets were far ahead. It’s clear: the Fed is running after inflation. But, for that very reason, monetary policy accelerated its aggressiveness like never before since Paul Volcker (the model is not him but Greenspan of 1994-1995).
Financial conditions tightened overnight. The stock market realizes But Fed won’t back down on rate hikes until inflation pressures, not stocks, give in. And in June it will add the balance cut. On the one hand, it is true, the fiscal policy that ignited the engines of the inflationary runaway has already turned off (and now it plays in reverse). On the other, the war in Ukraine (and the sanctions on Russia) are a negative supply shock with no solution in sight with the worst of both worlds, less activity at higher prices. The Fed is going to squeeze us, but how will it know not to hang up before it’s too late? At one extreme, Wall Street gave in. In the other, inflation persists (especially in energy and food). How much will the economy need to be slimmed down? The Fed went all out because it knows the strength of the starting point. It needs a sharp slowdown in spending but without a recession. A bear market will turn on a yellow light, but the bond curve, which threatened to invert, maintains the green light of a positive slope and is a more reliable signal.
The recession nests in the expectations, more now that the cold is felt in the street. Let the Philly Fed report say that it collapsed without warning and where more than half of the companies show a slowdown in May. Let the balance sheets of the retail trade say so, which speak of a consumer wary of paying more, and of excess inventories. Let the CEOs say it as they tell The Conference Board: 57% have a mild recession in mind (and less pricing power). Let them say it but let it be soon (and if possible, the core deflator will stamp another 0.3% like in February and March). Recession and mere slowdown are indistinguishable in this stretch, cash is stacked like never before in the last 20 years, and if the long rate stalls at 3% and the bears don’t take heart, then perhaps the stock will be claimed by its old owners, today on a sit-down strike. The Fed will be ruthless but James Bullard, the most aggressive hawk, swears and swears that there will be no recession but an excellent second half. A rally is not denied to a bear market either, and its absence is highly suspicious.
Source: Ambito
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