Is The Fed Hiking Into a Growth Slowdown? | The Big Conversation | Refinitiv

TL;DR

The Fed's reaction to equity market weakness and the impact of inflation on the Fed Put are uncertain, and investors should monitor employment data, yield curves, nowcasts, and the ratio of industrial stocks to the broader market for signals of a growth slowdown.

Transcript

In last week's episode, Roger Hirst in London,  focussed on the recent sell off in equity   markets with the big question being: How will fed  policymakers adjust the course of their signalled   tightening cycle if equity weakness continues?  Or, in other words, what is the strike of the   fabled Fed Put? And we'll explain that shortly.  Today, her... Read More

Key Insights

• 🛀 The Fed's reaction to equity market weakness is uncertain, as past instances have shown that it may choose not to support markets.
• ✋ In true bear markets, the Fed Put has not always been enough to stop significant declines in equity markets.
• 💐 The presence of inflation as a central concern for the Fed may lower the strike of the Fed Put, making it dependent on the impact on growth and employment.
• 🏍️ Lagging indicators like employment and growth data make it challenging to determine if the ongoing hiking cycle is a policy mistake.
• 🥳 Investors should focus on real-time indicators such as yield curves, nowcasts, and the ratio of industrial stocks to the broader market to gauge if the Fed is tightening into a growth slowdown.
• 🤩 The Fed has a key mandate of fighting inflation, and their asset purchase programs will continue to taper and halt by early March.
• ☠️ The market has priced in at least four rate hikes in 2022, with a 100% chance of a hike at the next Fed meeting in March. However, the persistence of inflation and the strength of the economy and labor market remain uncertain.

Questions & Answers

Q: What is the Fed Put and how does it affect markets?

The Fed Put refers to the Fed stepping in to support markets when they sell off. It usually involves a change in messaging rather than rate cuts or quantitative easing. The level at which the Fed Put is struck can vary, and it depends on how equity markets impact growth and employment.

Q: Has the Fed always supported markets during periods of equity market weakness?

No, there have been instances where the Fed did not step in, such as in 2018 when equity markets fell almost 20%. The Fed continued tightening and even hiked rates in December that year. However, it eventually paused its hiking cycle and cut rates in 2019 as economic data weakened and equities declined.

Q: How does the presence of inflation impact the Fed Put?

The Fed's focus on price stability as its core mandate means that the presence of inflation lowers the strike of the Fed Put. This implies that the Fed may be less inclined to change its stance on rate hikes unless equity market weakness begins to affect growth and employment.

Q: What real-time indicators can investors monitor to gauge the Fed's actions?

Investors can look at the yield curve, specifically the 2s10s spread, which tracks the difference between 10-year and 2-year Treasury yields. Flattening or inversion of the yield curve can signal slowing growth. Other indicators include the Atlanta Fed's GDPNow nowcast and the ratio of industrial stocks to the broader market.

Summary & Key Takeaways

• The recent FOMC meeting surprised investors with the Fed holding strong on hawkish policy, leading to questions about the strike of the Fed Put and how low markets need to go before the Fed reacts.

• Inflation has become a central concern for policymakers, potentially lowering the strike of the Fed Put and making it dependent on the impact of equity market weakness on growth and employment.

• Lagging indicators like employment and growth data make it difficult to determine if the ongoing hiking cycle is a policy mistake. Investors should focus on upcoming employment data releases for real-time indicators.