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 Blickre, a reporter focused on markets at Yahoo Finance. Follow him on Twitter @SPYJared.

The Nasdaq Composite (^IXIC) rose 2.1% on Wednesday, ending a seven-day losing streak that had once again disappointed the bear-buying crowd.

The problem is that 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 comes in the face of a doubling (or tripling) of the Federal Reserve’s unwavering determination to contain dramatic price inflation.

On Wednesday before the opening bell, a report by the Wall Street Journal’s top Fed whisperer, Nick Timiraos, caught investors’ attention, with the report suggesting another 75 basis point rate hike is coming from the central bank later this month.

That move would signal a continuation of the Fed’s summer game of tackling inflation, reducing anything that stands in the way of that fight. Which in this case means a tightening of economic conditions.

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

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

In late August, when Fed Chairman Jay Powell delivered a blunt speech in Jackson Hole, telling investors the Fed would raise interest rates “until the job is done” reducing inflation, markets sold off. Message received. Economic conditions are more stringent.

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

“I certainly wasn’t thrilled to see the stock market rally 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 official goals are stable prices, or 2% inflation, and maximum employment — no S&P 500 target has yet been added to the Federal Reserve’s congressional mandate.

However, these tighter economic conditions that Fed officials are aiming for have some potentially important positive implications for the Fed’s fight against inflation. A stronger dollar increases purchasing power for US consumers, lowers global commodity prices and in turn helps lower input prices. All of this is deflationary, just as the Fed would like it to be.

As Fed Vice Chairman Lael Brainard said in a speech on Wednesday, profit margins in several industries remain high after last year’s boom, and companies appear willing to accept lower margins as consumers react negatively to higher prices.

And as an added bonus, the dollar’s surge is also putting pressure on cryptocurrencies — that perennial thorn in the side of US regulators.

The Fed is also expressly pleased to see lower stock prices reduce the “wealth effect” of the country’s wealthiest and their associated spending. As long as this trickles down to the working class, the Fed is willing to tolerate some increased misery if His broad strokes manage to stuff the bloat 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 in stimulus while fending off a red-hot labor market.

But there we are in a disruptive 2022.

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

Federal Reserve Chairman Jerome Powell walks in Teton National Park, where economic leaders from around the world gathered for the Jackson Hole Economic Symposium outside Jackson, Wyoming, U.S., August 26, 2022. REUTERS/Jim Urquhart

“Our monetary policy discussions and decisions are based on what we have learned about inflation dynamics from both the high and volatile inflation of the 1970s and 1980s and the low and stable inflation of the past quarter century,” Powell said, highlighting three lessons from history.

First: The Fed takes responsibility for inflation and pushes back at first glance. Second: Don’t let public expectations derail your 2% inflation target. Third: Maintain a strict “until the job is done” policy.

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

“We are taking strong and swift steps to moderate demand so that it better aligns with supply and keep inflation expectations steady. We will continue to do so until we are confident that the job is done.”

And we’ll be watching the markets for signs that we’ve reached the end of that journey.

What to watch today

Financial calendar

  • 8:30 am ET: Initial Unemployment Claimsweek ended September 3 (expected 240.00, 232,000 previously)

  • 8:30 am ET: Continuous claimsweek ended May 21 (expected 1,435, 1,438 previously)

  • 3:00 p.m. ET: Consumer’s faithJuly ($33.0 billion expected, $40.15 previously)

Profits

  • American outdoor brands (AOUT), DocuSign (DOCU), FuelCell Energy (FCEL), National Drink (WHISTLE), RH (RH), Zumiez (ZUMZ)

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