Federal Reserve tightening; Dow Jones up to 658

The Federal Reserve entered a period of tighter monetary policy to fight inflation in the economy which hit a 40-year high of 9.1% in June.

The Dow-Jones Industrial Average rose 658 points on Friday. The Standard & Poor’s 500 The stock index rose 73 points on Friday. The NASDAQ index jumped 201 points on Friday.

So much for monetary tightening? Oh, all three indices suffered weekly losses.

Here is the weekly chart of the Dow-Jones

Caitlin Ostroff and Justin Baer write in the Wall Street Journal

“U.S. stocks rebounded on Friday, capping a volatile week in which investors tried to reconcile a flurry of corporate earnings reports and data that at times appeared to offer conflicting narratives on the economic outlook.”

The background:

“Major indexes rallied to end the week on another round of bank profits and data showing retail sales rose more than expected in June. banks published disappointing quarterly results.”

In other words, investors get conflicting information and this conflicting information leads to more volatile market movements.

Both pictures

The conflict seems to lie in the two narratives that investors seem to be dealing with. Both of these stories are not new and are modifications of what investors were thinking when the discussion was about whether or not inflation was a problem facing the Federal Reserve.

At that time, there was a group of investors – and policymakers – who believed that any inflation problem on the horizon was only going to be very short-lived, and therefore the Federal Reserve was not going to not really have a problem in his hands. and could get away with not really tightening monetary policy to any degree.

The other view was that inflation was going to be a bigger problem, something the Federal Reserve was really going to have to fight.

The latter account turned out to be closer to the truth, and the Federal Reserve really must have entered the fray.

Currently the stories are very similar, only the two images show the Federal Reserve tightening monetary policy.

The first image is the one captured in the Wall Street Journal article quoted above. Brad McMillan, Chief Investment Officer at Commonwealth Financial Network, says: “We are in a process of bottoming out.”

The period of economic downturn is coming to an end and we will soon return to a period of more expansive growth.

For McMillan, stock prices are now more closely aligned with projected earnings and many investors are already factoring in the effects of rising interest rates.

As I mentioned in previous articles published last week, bond markets have five- and ten-year inflation expectations that are priced in to government bond yields that show only relatively modest inflation gains in the short term. term and five-year inflation expectations. are below ten-year inflation expectations, which means that investors seem to believe that actual inflation will only be relatively short-lived and contained in the relatively short term.

In other words, inflation will soon peak and return to the level of the Federal Reserve’s inflation target.

The other view is that inflation will not be so fleeting and will turn out to be much higher, over time, than many people now think.

As in the previous situation, investors who believe that the current situation will only be very short-term and that inflation will quickly come back under control seem overly optimistic to me.

The likelihood of inflationary pressures being stronger and lasting longer aligns more closely with my picture of the future.

I think the market is pricing in a stable price recovery too quickly than warranted. For me, the battle is going to be harder than that.

The future

Mike Bell, global market strategist at JPMorgan Asset Management, is quoted in the Wall Street Journal as taking the second view mentioned above. “The risks of recession have increased since the beginning of the year.”

If we don’t get any pullback signal from consumers, it may not be as bad as people fear, but if we do get it, it’s a signal that recession risk is materializing.

This last scenario is the one that I believe will hold. The University of Michigan consumer confidence index for July 2022 was 51.1. Although this figure is higher than the June figure of 50.0, the index is hovering around its all-time low.

My feeling is that this index will drop in August and as we approach the fall.

If I’m right, that only adds to the possibility that the recession is worse than the “optimists” think.

We have to keep an eye on this scenario.

The image

The Standard & Poor’s 500 stock index has been falling since January 3, 2022. Here’s what the trend looks like.

In January 2022, stock market investors realized that the Federal Reserve was serious about its plan to start tightening monetary policy and raising its key interest rate, and to start reducing the size of its securities portfolio. .

Federal Reserve officials had overcome their attachment to the earlier narrative of rapidly disappearing inflation and pledged to tackle inflationary pressures in the economy.

But, when Fed officials finally convinced investors that they were really going to fight inflation, stock prices peaked and began to fall.

This is the table we have just above.

Now, as described above, many investors still seem to believe that “we are in a bottoming process”.

And, these beliefs are behind the market statistics we see today.

I believe, as in the previous case, that these optimists are wrong.

I believe the inflationary pressures are stronger than these people imagine.

I believe that the fight against inflation will be harder and longer than these people imagine.

Therefore, I believe the Standard & Poor’s 500 stock index chart will continue to decline and the chart will expand to the right.