Is the Federal Reserve finally in control? Markets Think So – On Their Responsibility

Investors may give central banks too much credit – or blame – for everything that happens to inflation.

Stocks are still volatile Even after the comfort rally in late May, which shows a close inverse correlation to indicators of global financial conditions such as Treasury yields, corporate debt spreads and US dollar demand. Pessimists see a recession coming, as it often happens when the Federal Reserve raises interest rates, while optimists believe the central bank can get to a good point to balance inflation and economic growth.

Inflation markets seem to be on the latter’s side.

In periods of high inflation, central bank policy cannot be understood by rates or bond yields alone. A common measure of “real” financial conditions in the United States is Treasury inflation-protected bond yields. In March and April, these were still negative even as normal yields rose, meaning investors see higher inflation ahead because they didn’t find the Fed’s hawkish stance aggressive enough.

But then inflation expectations began to fall steadily, as a series of data released in May pointed to a slowdown in parts of the economy – the housing market, for example. US inflation for April came in at 8.3%from 8.5% in March, raising hopes of a peak.

“The Fed has really done the job of pushing monetary policy to neutrality,” said Jonathan Baltura, fund manager at AXA Investment Managers and an expert on the inflation market. He prefers looking at short-term, inflation-adjusted rates that, as they rise, are wreaking havoc on stocks. But they are now settled around 0%, indicating that the adjustment may be over and markets have learned to see the Fed’s stance broadly.

If the market is pricing all of this right, it shouldn’t portend severe illness for stocks, even if the uncertainty keeps them volatile. Unadjusted for inflation, interest rates would peak around 3%, which is close to what happened in a pandemic bull market, when there was no alternative to taking risks. As the economy slows and corporate earnings guidance turns more negative, The numbers published on Wednesday He emphasized that the labor market is still strong.

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But new investor confidence in the Fed raises a much-neglected question: Do central banks really have this kind of tight control over inflation and growth?

The post-2008 period contradicts this concept, as does the current frenzy of inflation. In the eurozone, where fiscal stimulus has been more complex, Inflation this week came in at a record 8.1%.. US price policy cannot have much effect on the global phenomena fueled by the epidemic and war-related shortages – perhaps other than through brutal tightening to the levels of the 1980s. Inflation could easily come down from here like a jump again. Either way, the Fed doesn’t matter much. And it won’t have much say in the long-term implications of bringing supply chains ashore and transitioning to green energy production.

But interest rates affect stocks, and a central bank reacting without much actual strength is bad news for them, even without a recession. If inflation slows down from here, credit will be given to rates and To be left higher than may be necessary. Stocks may remain the only attractive investment, But ratings have historically been high Even after the recent sell-off, governments’ appetite for active fiscal policy has waned.

Conversely, higher inflation in the second half of the year may lead to exaggerated fears that this will be permanent. The recent lockdowns in China are a clear example of how supply disruptions may continue.

The illusion of being in control can bring relief, but it is dangerous.

The recent performance of the stock market has people talking about a possible recession in the United States. So what leading economic indicators have been a strong tracker of a recession, and what can you do to prepare for a recession? WSJ’s Dion Rabouin explains. Illustration: David Fang

write to Jon Sendreu at jon.sindreu@wsj.com

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