If the Fed is concerned at all about the newly-minted bull market in US equities and the potential for additional gains to undermine the inflation fight through the wealth effect channel, they’ll need to try a little harder to dissuade investors.
Stocks’ ongoing melt-up (or “crash-up,” if you like) continued into the US afternoon on Thursday when, 24 hours after the Fed unveiled what was supposed to count as an aggressively hawkish dot plot, the S&P traded above 4,400.
The world’s risk asset benchmark par excellence was poised for a sixth straight daily advance. Stocks are now higher than they were at liftoff.
The Nasdaq 100’s YTD gain is approaching 40%.
While acknowledging that the Fed can’t play Whac-a-Mole with every equity rally, I have a hard time believing this is ideal. Critics would note that during the Great Moderation years, and certainly post-Lehman, the Fed habitually stepped in to support stocks on a variety of excuses. That raises a simple question: Why, with inflation still double target (and then some on the core measures), can’t the Fed step in to arrest equity gains which threaten price stability?
Rather than venture an answer, I’ll reiterate that at the onset of rate hikes last year, some believed the Fed needed to wipe away most (or even all) of the pandemic-era gains in household wealth to have a chance at containing inflation. If there’s any truth to that, the job was never anywhere near done, and won’t likely ever be.
As a reminder, Q1’s $2.4 trillion gain in the value of corporate equities more than offset a $617 billion hit to property values. Thanks to consecutive stock-fueled gains in Q4 of 2022 and Q1 of this year, the total household net worth gain since the dramatic drop during Q1 2020 is back to $38 trillion.
Comparing total household net worth as of Q1 2023 to Q4 2019 is probably a better way to think about things. On that score, Americans are $32 trillion richer. The chart above illustrates the trajectory.
All nuance aside, this doesn’t feel like it adds up on some days. Common sense seems to dictate that a spendthrift society $32 trillion richer in just three years is a society where demand is likely to outstrip supply, leading to ongoing, upward pressure on prices. Americans are consumed with consumerism. When they have money, they’re generally going to spend it.
There are caveats aplenty, and I’ve explored them (all of them) in-depth in these pages over the last two years. Most wealth is concentrated in the hands of those with the lowest marginal propensity to consume which, as we saw post-GFC, can mean asset price inflation without much spillover to the “real” economy. Now that savings buffers have at least dwindled and with government transfer payments, student loan moratoriums and other forms of financial assistance for “regular” people rolling off, you can very plausibly argue that the spending impulse is set to wane, as those most inclined to spend each incremental dollar will now have fewer such dollars at their disposal. Then there’s the read-through of regional banking stress for credit provision. And so on.
But a superficial argument says the Fed hasn’t accomplished all that much. Core inflation, as Jerome Powell readily and repeatedly conceded on Wednesday, hasn’t really moderated over the past six or so months. Stocks are now trading as if nothing happened, and it’s not just the “Magnificent 7” anymore (although it’s still mostly those names, of course). And as the second chart above makes abundantly clear, “households” (misnomer or not) are vastly richer compared to three years ago.
Again, I acknowledge the simplistic nature of that argument. Having spent every night and day (weekends and holidays included) elaborating on every conceivable nuanced argument, I think I’m entitled (and duty-bound) to present the Occam’s razor case. There’s elegance in simplicity, after all. Bottom line: It may still be the case that the Fed eventually finds itself compelled to engineer a controlled demolition of the post-pandemic household wealth bubble in order to slay the inflation dragon.
Pain often seems to be the most effective teacher. My grandparents grew up in the midst of the great depression. How they viewed money, saving, and investing are alien to how the average investor operates today. The hard lessons of growing up so impoverished that children were literally working to put food on the family table are ones you never forget. The Fed in trying to engineer a soft landing is hoping that current generation investors will learn the lessons of 100 years ago without feeling the pain. It doesn’t seem like that’s a very realistic expectation.
Real easy. Cause a market crash which will cleanse everything, give us a deep recession, etc. The FED guys seem to have no clue as to what they’ve created! Let the craziness continue and the crash after will be like none other.
Inflation is not just happening in the US. Popping the US equity “bubble” is not likely to solve inflation problems in the UK or Germany. By that reasoning, the wealth effect may not be the cause of widespread inflation. Popping the equity “bubble” and having inflation remain high would be the end of the careers of the folks that have to act. The other variables that coincide with the rise of inflation are the COVID wind-down (which is old news, but still happening), the war in Ukraine, and the economic war with China.
The wealth effect in financial assets has re-ignited. That effect is concentrated in the higher-income, but the top two quintiles of household income are over half of consumer spending. For the bottom quintile, labor remains very tight so historically low UE and persistent wage growth is supporting their income and there’s that propensity to spend.
In housing assets, tight inventory is (anecdotally, in my area) driving bidding wars again; the housing wealth effect may be going from negative to more neutral. Apartment REITs reported a second quarter of rent inflation stabilizing at 5%, single-family REITs at 7-8%. If house prices stall and rents rise, it is hard to see how housing services will lead inflation lower.
Energy prices won’t deflate forever; stock action suggests investors see the bottom forming. Food inflation may be stabilizing at a too-high level. Bank loan officers may be tightening standards and stiff-arming CRE borrowers, but loan balances are still growing, both in published data and anectodally.
And investors who used to say “don’t fight the Fed” now say “don’t fear the Fed”.
All they need to do is make a move up in QT – beyond rates which can’t seem to go much higher its the easiest lever to pull (especially now with the market adjusted to take that increase)
It’s just baffling that they dont consider it necessary, and are just going to keep letting this get away from them.
Why do so many believe that even higher interest rates will succeed in bringing down inflation? The track record so far is not terribly convincing.
Perhaps yesterday’s remedies are not so effective anymore?
It’ll bring down asset prices, and let the wealth effect do whatever it can do. Which may not be enough, to your point, but we’re not even going to pull that lever.
Aat 20% mortgages (and basically no access to credit cards) spending grinds to a halt. So clearly the Fed has a remedy for inflation.
Cynically I just wonder who’s the beneficiary of this bubble?
That is correct and is clearly a remedy.
I don’t imagine the Fed thinks they have any other.
Who benefits? Whomever can afford to short whatever can blow up when housing crashes again, or is lucky enough to take a position just before the SHTF.
After 1.5 years of hiking, Fed Funds rate is still not higher than core PCE inflation, and now Fed thinks they are so close to terminal rate that they want to take cautious little pauses between cautious little steps. Because, going too hastily from zero % real rate to 0.5% real rate might be a dangerous overshoot.
The Fed may think they are sending a hawkish message through this stern pause, but the market’s reaction is otherwise.
I think it’s less that yesterday’s remedies aren’t as effective as much as this time is different. There is just a lot more money in the system than there was when the Fed last went on a major hiking cycle: QE, pandemic stimulus, student loan forbearance, etc. Interest rates at 5% aren’t soaking up enough of that excess.
As hinted at below, if the Fed pulled a “Volcker” and immediately raised rates to 10% I think inflation would be tamed. Of course it would come with a massive recession and other large knock-on effects.
Ten % was a passing fancy on the way to 18.5% and a 20% bank prime lending rate. I bought two houses during that era and one other in the neighborhood. We did survive and boy, did I start making money in Treasuries.
If the US isn’t willing to grow the US economy out of its inflation problem (gets my vote), then our elected representatives need to either increase taxes or cut spending. It seems that Powell is effectively “tossing the ball” back to Congress.
Our Federal deficit has about doubled since the pre-covid decade and the deficit is about ready to get much worse as social security runs out of funds.
Therefore, Powell is drawing a line in the sand: The Fed/monetary policy has gone as far as they can without tanking the US economy. The next move is yours, Congress, as it is really the elected representatives responsibility to fix this problem from the fiscal side.
The saying If something can’t last forever, it won’t….I personally favor a 20% minimum tax rate for the top 20% as a nice beginning…I would also really look at health care… Having said this, if long rates start to rise and we run out of the extra money in the system,(2024?), and you have the younger people strapped with college debt, I think things will sort themselves out…Remember though, barring radical demand decline, higer prices tend to be very sticky….
What if they want to demolish the wealth bubble?