When will the Fed rescue equities? Does the vaunted “Fed put” still exist? If so, where’s the strike? Is it February 2020 levels? Must we lose all of our pandemic wealth gains? Can’t we keep just a few index points — you know, for posterity?
What if the strike is even lower? Have we come that far? Have the benefactors with the printing presses really turned against us entirely? Are they that offended by a “little” inflation?
Those are among the most pressing questions for traders nearly halfway through 2022, a year during which both stocks and bonds saddled investors with sizable losses over five months, raising questions about what recency bias still swears are “bedrock” correlations that should hold, come hell or high macro vol.
As I sit here a week into June, US Treasurys are down 9% for the year, investment grade credit more than 12%, US equities 14%. At some point, the Fed is supposed to fix this situation. Only they can’t because — I don’t know, something about Main Street paying $12 for bananas.
I’ll drop the sarcasm. Sometimes it’s too subtle for readers. In the era of social media, dry humor rarely works. Satire is dead, and subtlety is a foreign concept.
The questions raised here at the outset are probably easier to answer than we’ve led ourselves to believe. Over the past six months, we’ve convinced each other that more analysis is better — that complexity is somehow a virtue when speculating about the unknowable.
The Fed wants tighter financial conditions and one way to achieve that is through lower stock prices. If the goal is to engineer a large, but controlled, demolition, it’s worth noting that in some contexts, what we’ve seen so far scarcely counts. BMO’s Ian Lyngen and Ben Jeffery used a 200-day rolling look back (figure below) and noted that “throughout each cycle since 1970, the average peak-to-trough drawdown for the S&P 500 has been 36%.”
Lyngen, in his scrupulously diplomatic cadence, wrote that, “with the height of the selloff in the current regime reaching -18.6% on a closing basis, if history is any guide there is certainly room for more weakness in equities even before accounting for the current inflationary backdrop.”
So, if the question is whether stocks can fall further before the situation can accurately be described as any semblance of harrowing (or even meaningful) in a historical context, the answer is “yes.” Unequivocally yes.
However, the Fed wants an orderly selloff, which means the 19% decline from the peak in January to the lows last month may well have been “enough” for now. I’m always keen to remind folks that, when it comes to bond yields, and particularly real yields, it’s the rapidity of the selloff that counts, not any absolute level. The speed of a bond selloff typically dictates equities’ response, and in that regard, the surge in real yields seen this year was a multi-standard deviation move. Hence the indigestion in stocks.
All of that is crystallized in financial conditions, which take account of both rates and equities, as well as credit spreads and the dollar. It’s through financial conditions that asset prices affect the real economy — or at least that’s the talking point. As BMO’s Lyngen went on to note, the recent tightening impulse ranks among the most acute episodes ever outside of the initial COVID shock and the GFC.
The bottom pane in the figure (above) shows the MoM change in financial conditions. Try to envision how large the spike seen over the last few months would appear in the absence of the anomalous surges that accompanied March 2020 and 2008/2009.
Here again (and this ties it all together), it’s the rapidity of the move that matters, not so much the absolute level. Financial conditions are just now back to 2019 levels, but as Lyngen wrote, “the speed of the surge over the past few months in 2022 is on the upper-end of the pace of increase we have seen historically.”
Given how much the Fed has accomplished in that regard over such a compressed time frame, it’s reasonable “to suspect the Committee would prefer a period of stabilization or at least more gradual tightening,” BMO went on to write.
So, coming full circle, and speaking to the utility of taking a common sense approach to addressing the most vexing market quandary, if the question is “Has the stock selloff run far enough?” The answer is “Likely yes, but only for now.” The same applies to financial conditions more broadly.
The worry, if you’re hoping for stocks to stage a durable rally, is that one could pretty easily argue equities need to do most of the heavy lifting if the Fed does intend to engineer a further significant FCI tightening impulse. If not, the onus would fall on longer-end bond yields, credit spreads and the dollar. If the choice is between excessive rates volatility, dramatically wider credit spreads, inexorable dollar strength or another 15% to 20% down on the S&P, the Fed will take the latter every time.
Oh, and remember: An orderly selloff is no selloff at all.
Mr. H, Please don’t drop the sarcasm, dry humor, or satire. We definitely need more sarcasm in our current neurotic uptight politically correct culture. I don’t always agree with everything, for example Ur affection for MMT, but that’s because I have an upper Midwestern value system.(I watched Archie Bunker with my Dad while growin’ up) Ur articles are always insightful and Ur recent article exposing crypto hype was rigorous and excellent !!
If MMT proponents would drop the “Theory” thing it would help. It’s not a “theory,” it just is. The government doesn’t need to source a currency it issues from you in the form of taxes and it doesn’t need to borrow a currency it issues from anyone else either. That doesn’t make any sense. It’s a contradiction in terms. I so wish MMT had never become “a thing.” It’s confusing to people. There’s no such thing as “MMT.” There’s just “how it works.” Plainly, the sole source of something (anything, really, it doesn’t have to be dollars or pounds or yen or a currency at all) doesn’t need to source that something from somewhere else. That thing (whatever it is) doesn’t even exist outside of the source and no one else can produce it. There’s no such thing as “US dollars” without the US government. If the US army wants five new tanks, and the Pentagon can convince Congress those tanks are necessary, the Pentagon will get those tanks. Contrary to popular belief, your taxes don’t pay for those tanks and neither does China through Treasury purchases. The money comes from thin air and then we retroactively pretend we paid for it by taking your money (taxes) or selling interest-bearing dollars (USTs) to China and Japan. I realize that’s a bitter pill for people to swallow, but it’s the truth.
… and, if I may add, a further aspect of MMT (“we can print/buy/afford whatever we want… till inflation occurs”) is sustained (I won’t say proven since it’s still descriptive rather than theorized) by today’s inflation.
There’s apparently a fair amount of economic debate as to how much fiscal COVID relief is to blame for present day inflation vs. supply chains disruptions, changes in good vs services consumption and the war in Ukraine. Still, it seems clear COVID relief is at least significantly responsible for inflation in the US (lower relief packages elsewhere led to lower inflation) i.e. retrospectively, it’s clear we printed too much money and it triggered inflation.
Fully as MMT described the limits of fiscal largesse.
Too bad congress doesn’t understand that MMT just is. Without them the country will never be able to unshackle itself from old concepts, like a flat earth, that are roadblocks to moving civilization forward. It’s frightening to think we are being held hostage by a small group of people who, for the most part, don’t have a clue because all their time is spent on taking care of themselves while they swear they are only concerned about the electorate. That’s not a theory, it just is.
Walt, I know you must be tired of repeating/battling the MMT issue but please keep doing it until people wake up to the facts of the matter. This is required because sadly the MMT issue will continue to be politicized to bludgeon the “libs”. The code for those who refuse to see the light is “upper Midwestern value system”
Money printing should be non-inflationary as long as the money is spent to sustainably grow the economy (not just create a “flash in the pan” increase in demand) or is spent to invest in R&D that can result in a long-term benefit to mankind (i.e. science, technology, energy).
The problem is when it is printed and used for a short-term reason that does not provide long-term benefits.
“ He’s cute, ain’t he? Only problem is, he’s got a little bit of Mississippi leg hound in him. If the mood catches him right, he’ll grab your leg, and just go to town. You don’t want him around if you’re wearing short pants if you know what I mean. A word of warning though: If he does lay into you, it’s best to just let him finish.” Cousin Eddie, Christmas Vacation, speaking metaphorically about the Fed in a high inflation period
Fantastic! MS leg hound. My first time. What a hoot.