As the Federal Reserve hastily withdraws the powerful tide of easy money that kept the U.S. economy buoyant through the worst of Covid, the deepening bear market for the S&P 500 and other stock indexes is revealing, as Warren Buffett famously said, “who’s been swimming naked.”
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The Fed’s fastest rate-hiking since the early 1980s and unprecedented pace of balance-sheet tightening has been wrenching for U.S. investors. But the sudden dearth of liquidity is wreaking even greater havoc via international currency markets.
With global recession looming and Vladimir Putin threatening to resort to nukes, investors are finding safety in the highest U.S. Treasury yields in 13 years. The endless flow of cheap dollars, which whetted risk appetites and afforded low borrowing costs around the globe since the 2008 financial crisis, is now rushing back to the U.S., pushing the greenback to 20-year highs. That’s exacerbating inflation outside the U.S., forcing most central banks to follow the Fed’s lead to protect their own currencies and making their economies even sicker in the process.
Though evidence of financial fragility is growing, Fed policymakers seem determined to continue their interest rate-hike sprint until something actually breaks.
A History Of Fed Reserve Policy Pivots
When the Fed’s need to tighten to meet its domestic inflation mandate creates problems for the rest of the world, markets can quickly come unglued. That happened in early 2016 and late 2018. In both cases, the Federal Reserve quickly pivoted away from its tightening plans.
Speculation is rising on Wall Street that the Fed could again turn dovish earlier than expected, partly because of the global reverberations.
Yet in an Oct. 6 appearance, Federal Reserve Gov. Christopher Waller sought to assure markets that this time will be different.
“I’ve read some speculation recently that financial stability concerns could possibly lead the FOMC to slow rate increases or halt them earlier than expected,” Waller said. “Let me be clear that this is not something I’m considering or believe to be a very likely development.”
Inflation Too Hot For Fed, But Stocks Roar Back
Fed Hawks Vs. Fed Doves
Yet even within the Fed, divisions have arisen.
In an Oct. 10 speech, Fed Vice Chair Lael Brainard said the combined force of rapid rate hikes by the Federal Reserve and other major global central banks is “more than the sum of its parts.” She cited negative “spillovers” from higher interest rates, a stronger dollar and weaker demand from trade partners.
Because those effects of tightening take time to be felt, Brainard argued for “moving forward deliberately” with rate hikes. That bears no resemblance to the Fed’s current approach. A fourth straight 75-basis-point rate hike is expected Nov. 2. After Thursday’s CPI data showed inflation remains hot, markets now see a fifth straight supersize move in December.
Brainard is among the lonesome doves. Minutes from the Sept. 21 Fed meeting released on Wednesday noted that “several” committee members preferred “to calibrate the pace of further policy tightening.” Yet “many participants” argued that “the cost of taking too little action” outweighed the risk of not tightening enough.
Waller argued that the Federal Reserve has “tools in place to address any financial stability concerns.” That includes a standing repurchase agreement facility to support foreign monetary authorities.
Brainard is more circumspect. “A sharp decrease in risk sentiment or other risk event that may be difficult to anticipate could be amplified, especially given fragile liquidity in core financial markets,” she said.
Global Financial Markets On Edge
While the dam hasn’t broken, global financial markets show signs of heightened stress.
Massive swings in British bond prices amid missteps by Prime Minister Liz Truss’ new government forced the Bank of England to intervene as pension funds unwound safe bets that suddenly turned risky. The…
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