Fed Pause? Markets Hope So, But Likely Not Yet.
2022.05.31 14:16
Will the Fed pause its rate hikes as markets correct? That is the question that everyone is trying to answer. Of course, after more than a decade of monetary interventions, investors have developed a response to market declines and the
Each time a more substantial market correction occurred, Central Banks acted to provide the
Fed Balance Sheet Bailouts vs S&P 500
So, with the market having one of the roughest starts ever to a new year, investors are asking the question:
Fed Still Sees A Bull Market
Investors have been under a tremendous amount of pressure this year. As Ethan Harris recently indicated in a note from BofA:
.
The chart below is an
How Investors See The Market
In other words, as I discussed in February, everyone is wondering where the “Fed Put” is. To wit:
In February, the BofA fund managers survey pegged 3750 as the level they thought the resided.
Fed Put – 3700
However, by April and May, BofA revised its levels down to 3500.
Fed Put May-2022
Out targets are slightly different as they are a function of Fibonacci retracement levels from the March 2020 closing lows. From the peak close of the market, the targets are:
- 38.2% rally retracement = 3829 = 20% market decline
- 50% rally retracement = 3523 = 27% market decline
- 61.8% rally retracement = 3217 = 33% market decline
S&P-500-Weekly Chart
Interestingly, a 33% decline only erases market gains from early 2020.
There are two reasons why the might be lower than 3500.
The first reason is the Fed sees things differently than Wall Street or retail investors. While the market has declined this year, the market remains higher than in 2020.
The Fed doesn’t mind a in asset prices to reduce excess market speculations. Furthermore, the market decline also contributes to its tightening monetary policy to mitigate inflationary pressures.
How The Fed Sees The Market
While equity prices are important, it’s the credit market the Fed focuses on.
No Credit Stress Means No Fed Pause
When it comes to the financial markets, the Fed’s primary focus is After the financial crisis, the stability of credit markets became a primary focus of the Federal Reserve. As noted previously:
While retail investors wonder when the Fed will intervene, there is little evidence of severe market stress. Currently, credit spreads are not spiking, suggesting the bond market is functioning normally. With inflation running hot, the spread between junk and A-rated bonds gives the Fed room to hike rates for now.
Junk Bonds To Rate Spreads Vs S&P 500
While credit spreads have risen and markets declined, such has remained orderly, as shown by the subdued rise in volatility. However, the Fed is sensitive to credit markets and previously acted quickly at the first hint of turmoil.
VIX vs S&P 500
Absent a disorderly meltdown, the Fed will remain focused on stocks being still above their pre-crisis peak. As BofA notes:
From that view, and with little stress in the credit market, the Fed can remain focused on combating inflation.
However, make no mistake, as the Fed continues to hike rates, there is an increasing risk that markets rapidly become .
Will the Fed their rate hikes?
That answer is
The only questions are and
