Stocks Send Fed A Message: Try Harder

Neel Kashkari isn’t about to let a recession stop him from bringing inflation back down to 2%.

That’s not a joke. I mean, it’s funny, assuming you can find humor in the prospect of a recession. But Kashkari actually said that on Wednesday.

Although July’s cooler-than-expected CPI report was “welcome,” the Fed is “far, far away” from any sort of victory over inflation, he told the Aspen Ideas Conference. The Fed’s final victory could be of the Pyrrhic variety. A recession is possible, Kashkari acknowledged, perhaps even in the “near-term.” But if inflation is still elevated, a downturn won’t deter policy. “We have to get back to 2%,” he insisted, reiterating his view that rates should be near 4% by year-end and 4.4% by the end of 2023.

The front-end of the Treasury curve, which rallied sharply in the aftermath of the CPI report, trimmed gains. Two-year yields were lower by just six basis points, after falling some 20bps earlier in the session.

Kashkari’s remarks followed hawkish comments from Charles Evans. Both were plainly intent on dissuading markets from overdoing it based on a single month’s CPI report. As discussed here, the knee-jerk reaction across assets, and particularly a pronounced move lower in the dollar, were contrary to the Fed’s inflation-fighting efforts.

During the same Wednesday remarks, Kashkari called the idea that the Fed will cut rates while inflation is still elevated “not realistic.” The Fed, he pressed, won’t ease “until we get convinced that inflation is well on its way” to 2%. That’s not quite the same as saying no rate cuts until 2%, but suffice to say four- or five-handle CPI won’t cut it — no pun intended.

As a reminder, the path to sub-5% inflation (either on core CPI or headline PCE) by mid-2023 is challenging (figures above).

Just in case anyone was confused or inclined to ignore officials’ efforts to restrain markets, the Fed enlisted someone whose name holds more weight than Kashkari and Evans: Nick Timiraos, the Wall Street Journal‘s “Fed whisperer,” who carried water for the Committee in June when disconcerting data delivered during the self-imposed quiet period left officials with no options for telegraphing their intention to deliver the largest rate hike since 1994. “Fed Likely to Want Further Evidence of Inflation Slowdown,” Timiraos trumpeted, in a headline which, in my opinion anyway, was aimed at short circuiting the rally in equities.

“Suffice it to say the write-up suggested that a single data point (i.e., July CPI) would not be enough confirmation that inflation has definitively turned a corner,” BMO’s Ian Lyngen and Ben Jeffery wrote on Wednesday afternoon. “Regardless of whether the Journal article was a plant and Timiraos is once again functioning as the Fed’s mouthpiece, [rates] certainly traded it that way,” they added, noting that “the combination of a strong 10-year auction and hints the Committee isn’t necessarily slowing the tightening cadence partially reversed the knee-jerk steepener” seen early on, when the front-end rally looked poised to stick around, even as long-end yields moved back to unchanged in the setup to the 10-year sale.

Rates are better at nuance than stocks. Rates sometimes hear things that aren’t there because they’re straining for nuance. Stocks, by contrast, hear whatever they want to hear, which in many cases means ignoring nuance or, in Wednesday’s case, ignoring implicit exhortations to cease and desist.

Kashkari may well mean it when he says a recession “won’t deter” the Fed in its quest to vanquish the inflation dragon. But equities, like inflation (and dragons), can be unruly. Stocks simply ignored Fed officials (and Fed mouthpieces), held fast to gains and closed near the highs. It was the best day for the S&P since Jerome Powell inadvertently sparked a rally while speaking to reporters following last month’s rate hike (figure below).

That isn’t ideal for the Fed. It’s tolerable as long as it doesn’t run too much further, but equities are really pushing it now. Expect Fed officials to push back. If Wednesday was any indication, policymakers will need to push pretty hard if they want to dissuade stocks in the face of favorable data.

As frustrating as this may be for many market participants, Fed officials aren’t likely to countenance additional gains beyond, say, 4,200 on the S&P. That’s probably a bridge too far.

Bottom line: If you’re betting on additional upside from here, you’re fighting the Fed. Good luck.