Why the Fed wants to see a strong dollar and falling stock prices

Why the Fed wants to see a strong dollar and falling stock prices

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Thursday, September 8, 2022

Today’s newsletter is from Jared Blikre, a market-focused reporter at Yahoo Finance. Follow him on Twitter @SPYJared.

The Nasdaq Composite (^IXIC) posted a 2.1% gain on Wednesday, ending a seven-day period of losses that had once again frustrated the crowd.

The problem is, rising stocks are the last thing the Federal Reserve wants to see.

Sudden reversals of fortune – both up and down – are common in illiquid bear markets.

But Wednesday’s rally flies in the face of a Federal Reserve doubling (or tripling) in its steely determination to curb runaway price inflation.

On Wednesday, before the opening bell, a report by the Wall Street Journal’s top Fed commentator Nick Timiraos caught the attention of investors, with the report suggesting another 75-bp hike will come from the central bank at the end. Of this month.

That move would mark a continuation of the Fed’s summer gamble to tackle inflation by clamping down on anything that stands in the way of that fight. Which in this case means tightening financial conditions.

The simple outline of tighter financial conditions is a stronger US dollar, wider spreads in bond markets and lower equity prices. Trigger-happy stock bulls should read that sentence again as they remain, in fact, fighting the Fed.

All other things being equal, tighter financial conditions require investors and consumers to be more deliberate about where and how they spend and borrow.

In late August, when Fed Chairman Jay Powell delivered a scathing speech at Jackson Hole, telling investors that the Fed will raise rates “until the job is done”, reducing inflation and short markets. Message received. Tighter financial conditions.

Minneapolis Fed Chairman Neel Kashkari made waves last week when he acknowledged he preferred this market reaction to what was seen after the Fed’s FOMC meeting in July. Which was a market rally that saw the S&P 500 gain 2.6% and the Nasdaq up more than 4%.

“I was certainly not excited to see the stock market soar after our last Federal Open Market Committee meeting,” Kashkari told Bloomberg in an interview.

And while the Fed has a third “shadow mandate” of financial stability — its formal targets are stable prices, or 2% inflation and maximum employment — there has yet to be an S&P 500 target added to the Federal Reserve Congressional mandate.

Still, these tighter financial conditions that Fed officials are seeking have some potentially significant positive impacts on the Fed’s fight against inflation. A stronger dollar increases the purchasing power of US consumers, lowers global commodity prices and, in turn, helps lower input prices. All of this is disinflationary, which is exactly what the Fed would like.

As Fed Vice President Lael Brainard said in a speech Wednesday, profit margins in many industries remain high after last year’s boom and companies seem willing to accept lower margins as consumers respond negatively to higher prices.

And as an added bonus, the rising dollar also puts pressure on cryptocurrencies – that perennial thorn in the side of US regulators.

The Fed is also expressly pleased to see lower stock prices dampen the “wealth effect” of the country’s richest and their associated spending. To the extent that this “runs over” the working class, the Fed is willing to tolerate an increase in misery What if his broad strokes manage to stuff the inflation genie back into the bottle.

It may seem counterintuitive, at best, that the Fed’s dual mandate has been reduced to a Faustian bargain – balancing the need to reign in trillions of stimulus while pulling a bubbling labor market out of the boil.

But that’s where we find ourselves in an upside-down 2022.

And as Powell reminded investors last month, history remains the guide for his Federal Reserve.

Federal Reserve Chair Jerome Powell walks through Teton National Park, where financial leaders from around the world gathered for the Jackson Hole Economic Symposium outside Jackson, Wyoming, USA, Aug. 26, 2022. REUTERS/Jim Urquhart

Federal Reserve Chair Jerome Powell walks through Teton National Park, where financial leaders from around the world gathered for the Jackson Hole Economic Symposium outside Jackson, Wyoming, USA, Aug. 26, 2022. REUTERS/Jim Urquhart

“Our deliberations and monetary policy decisions are based on what we’ve learned about the dynamics of inflation, both from the high and volatile inflation of the 1970s and 1980s and the low and steady inflation of the last quarter century,” Powell said. , pointing out three lessons from history.

First: the Fed takes responsibility for inflation and backs off at first sight. Second, don’t let public expectations get out of control of your 2% inflation target. Third: Stick to the strict “until the job is done” policy.

“These lessons are guiding us as we use our tools to reduce inflation,” Powell said.

“We are taking strong and quick steps to moderate demand to better align with supply and to keep inflation expectations anchored. We will continue until we are confident the job is done.”

And let’s watch the markets for signs that we’ve reached the end of this journey.

what to watch today

economic calendar

  • 8:30 am ET: Initial unemployment claimsweek ending September 3 (240.00 expected, 232,000 previously)

  • 8:30 am ET: Continuing Claimsweek ending May 21 (1,435 expected, 1,438 previously)

  • 15:00 ET: consumer creditJuly ($33.0 billion expected, $40.15 previously)

earnings

  • American outdoor brands (AOUT), docusign (DOCU), FuelCell Energy (FCEL), National Drink (Effervescence), HR (HR), zumiez (ZUMZ)

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