What will the Federal Reserve do next?
What will the Federal Reserve do next?
What will the Federal Reserve do next?
This is the question the major newspapers are asking their readers in the Saturday morning papers.
On the second page of the Wall Street Journal, we read: “Jobs Report Likely Keeps Fed On Track For Rate Rise In March.”
On the front page of the Financial Times, we read: “US Unemployment Rate Drops To 3.9% Giving Fed Ammunition To Raise Rates.”
And, on the first page of the business section of the New York Times, we read: “Unemployment Is Falling Fast, Adding Pressure For Interest Rate Increases.”
Why is this important?
Well, Gunjan Banerji and Anna Hirtenstein write in the Wall Street Journal:
“The S&P 500 kicked off the new year with a fresh record on Monday but came under renewed pressure after the Federal Reserve’s minutes confirmed its intention to pull back stimulus and suggested it might do so sooner and faster than previously planned, due to high inflation.”
“On Friday, the December jobs report was the latest of several confusing signals about the economic recovery that investors are evaluating.”
As mentioned earlier, the unemployment rate dropped to 3.9 percent, a number that many analysts accept as a number close to what is considered “full employment.”
And, if the economy is very close to full employment level, with lots and lots of liquidity hanging around the financial system, then the economy must be susceptible to greater rates of inflation.
If sustainable, higher rates of inflation are on the horizon, the Federal Reserve must get its act in order and tighten up on its monetary policy.
This will mean less liquidity and higher interest rates.
New Stock Market Highs
The new year did start off with the stock market hitting new historical highs.
The Dow Jones Industrial Average closed out on both Monday and Tuesday with new historical highs.
The Standard & Poor’s 500 Stock Index hit a new historical high on Monday.
My assessment at that time was that investors were interpreting the position of the Federal Reserve as one where interest rates would be allowed to rise in 2022, but that the Fed did not seem very intent upon selling some of its securities portfolio, hence, bank liquidity would not be threatened.
However, as the week went along, more analysts began to feel that the Federal Reserve might actually work to reduce bank liquidity, hence acting in a way that was more restrictive than earlier thought.
Hence, all major stock market indices fell for the rest of the week.
Inflation Data
But, adding to this, more information on the rise in the inflation rate came to light. And, the information on inflation showed that the problem of inflation was not just an American problem.
Inflation in Europe hits a new record.
“The European Union’s statistics agency Friday said consumer prices in December were 5 percent higher than a year earlier, a pickup from the previous record of 4.9 percent in November.”
This rise raises questions about the monetary stance of the European Central Bank. The ECB president, Christine Lagarde, has been arguing that the European Central Bank needed to continue its policy of quantitative easing for a little bit longer. Ms. Lagarde was not ready to raise European interest rates at this time.
This, of course, was good news for the Federal Reserve System because it meant that any tightening it might do would not be matched by another major central bank.
Now, with European inflation rates pushing higher, Ms. Lagarde and the ECB may find it a little bit harder to maintain such an accommodative position.
And, if the ECB starts raising its policy rate, that will just put more pressure on the Federal Reserve to raise its policy rate of interest.
Here is an overview of the inflationary situation in the United States and in Europe.
But, we are not done yet.
The United States Job Situation
Also, on Friday, investors got new information on the jobs market.
First, as mentioned above, the unemployment rate dropped to 3.9 percent, indicating that the U.S. labor market was not doing too badly. And, in 2021, the U.S. added a record number of jobs to the labor market.
Second, the latest jobs report indicated that the average hourly wage in the U.S. rose 4.7 percent in December from a year earlier.
Wage growth before the pandemic set in was around 3.0 percent.
This divergence, obviously, raises concerns about how wage pressures might be impacting the future of inflation.
Investors are concerned about this connection and that was also reflected in the stock market at the end of the week.
Stock Market Split
Mr. Banerji and Ms. Hirtenstein do spend some time on the analysis of stock movements.
One thing they point out is the bifurcation taking place in the stock market:
“Underneath the surface, the selling has been even more extreme. Nearly 40 percent of the stocks in the Nasdaq Composite have lost half their values, and almost two-thirds are in bear markets or down 20 percent from their highs.”
“This is a dynamic that hasn’t emerged since 1999 and highlights how volatile individual stocks have been as investors position for the next phase of the economic recovery.”
Obviously, many things are going on in the stock market these days, representing the states of disequilibrium and dislocation that exist within the economy.
A lot is going on and in this period of radical uncertainty, volatility is to be expected.
Back To The Federal Reserve
This brings me back to the Federal Reserve.
To me, the Federal Reserve has created this situation. And it is not a good situation.
To discuss what is going on in the stock market, I have spent more than three-quarters of this post talking about what the Fed is doing or what the Fed might do.
This is not the way it should be.
If the Fed is doing its job and doing it well, we should not be discussing it at all. We should be focusing upon companies, sectors, or more micro-issues.
But here we are and the Fed is dominating the scene. Thus, we must continue to focus on the Fed and on what the Fed is planning to do. 2022 may be a very interesting year.
If investors believe that the Fed is tightening its monetary policy, don’t be surprised at the drop the stock market takes.
Read More: The Stock Market: What Will The Fed Do Next