Hot stock market boom fuels concerns about Wall Street's large rate-cut wagers

Hot stock market boom fuels concerns about Wall Street's large rate-cut wagers

Hot stock market boom fuels concerns about Wall Street's large rate-cut wagers

A surge in stocks posed a threat to Powell, as the S&P 500 reached a new high due to anticipation of rate cuts. The Fed is concerned about the loosening of financial conditions.

S&P 5 on anticipated rate reductionsJerome Powell is concerned as the equities rise, which reached a record high of $00, has called into question the authority of the Federal Reserve.

Is the Federal Reserve Overreacting to the Equity Rally? Jerome Powell has to respond to that issue quickly since his attempts to tighten the economy's reins have been placed under strain by three months of advances.

Motivated by speculative wagers that the central bank would begin a protracted sequence of rate reductions this year, the S&P 500 broke new highs in five straight sessions prior to Friday, continuing an upward trend that has increased shareholder value by $8 trillion. The profit caused the financial situation to drop to its lowest point since the beginning of 2022.

Gains in stocks, and the impression of wealth they generate on Wall Street and Main Street, have the potential to undermine attempts by policymakers to control inflation by rekindling the cycles of investment and consumption. This is something that policymakers seldom say aloud. has the ability. According to a new research that was posted on the website of the National Bureau of Economic Research, equities have the most impact on financial circumstances, and monetary policy has a significant role in affecting them.

At the Fed meeting next week, dovish signals will surely be welcomed by bulls, but there are risks associated with relaxing too quickly. Among them are: The market has overheated, and the Fed chair's attempts to ease excessive price pressure are hampered by the ensuing economic money impact.

Chief investment officer of Leuthold Group Doug Ramsey said, "Intuitively, to me, that would be more inflationary when you're at full employment and then you see a significant increase in stock market wealth." "In and of itself, the stock market's surge in expectation of a Fed rate drop is an easing mechanism. Ironically, this could make a rate decrease less likely in the next months.

The S&P 500 climbed for the twelfth time in thirteen weeks, rising 1% in only five days. Measured by tightness in the money, bond, and stock markets, financial conditions have significantly eased as a result of this rise. The investment environment is actually more accommodating than it was before to the central bank's vigorous policy-tightening almost two years ago, according to Bloomberg indexes, mostly because of the market boom.

The cost of financing for mortgages has decreased in order to draw in property purchasers, with an emphasis on additional low rates. The current state of stock prices is at an all-time high, which may encourage consumer spending. According to the most recent Fed figures available, U.S. consumers' equity holdings reached $43 trillion in the third quarter, or 38% of their financial assets.

The Fed's decision to become more dovish is hampered, according to Henry Allen, macro strategist at Deutsche Bank AG, by favorable financial circumstances and better-than-expected economic statistics. He remembers Powell telling Congress in 2023 that the Fed would be prepared to "increase the pace of rate hikes" if payrolls continued to grow and inflation kept steady.

Furthermore, Powell has repeatedly emphasized the significance of general financial conditions during the rate-hike cycle, emphasizing the "policy restraint we are imposing."

"Clearly inflation is now pretty close to target, so this is not an exact equivalency with today, but the potential downside is that easier financial circumstances lay the foundation for inflation to begin to creep up again," Allen said in a note. "In the current cycle, the Fed was once again more hawkish when economic conditions have eased."

Since the Fed has rescued the market on several occasions in the past few decades—from the 2008 crisis to the regional banking unrest of last year—monetary policy has become more important in determining the destiny of financial assets. This is a well-known investing premise. A model emphasizing the effect of asset prices on the economy was provided by Ricardo Caballero of the Massachusetts Institute of Technology as well as Alp Simsek of Yale University in an NBER study titled Central Banks, Stock Markets, and the Real Economy.

It refers to a Federal Reserve study that discovered every extra 1% gain in stock prices is linked to an increase in economic growth of 2 basis points in the next year and 4 basis points in the following two.

The recent stock market boom provides the Fed with a tenuous justification to postpone a meaningful rate decrease. However, Simsek said in an interview that a variety of factors must be taken into account when making such judgments, such as further market events that indicate tight financial circumstances, including an increase in inflation-adjusted rates.

Regarding the March meeting, he stated that "I can see the decision going in either direction as well as certainly the Fed is in a difficult position." "They may be more diligently, especially if they would like to take back that decision later."

Nevertheless, this may be the height of money's power. Wall Street experts predict that once the S&P 500 average surpassed its year-end objective this week, the stock market surge will lose steam. Furthermore, 61% of American households—mostly rich ones—have stock investments.A Gallup poll from last year indicated that it was still dominant over ownership. This shields the fortunes of a great number of individuals from short-term market swings.

Rebuttal: If past performance is any indication, equities wealth among Americans may keep growing. As of last week, the S&P 500 has entirely rebounded 13 times since the 1940s after going through an extended period of depression. The index increased in each of the cases, rising by an average of 29% in the 19 months before the final peak. If this bull market continues at its current pace, stock owners would benefit by around $15 trillion.

"People spend more money when they are content with the state of their portfolio. Additionally, the money impact may undoubtedly boost economic activity, according to Yardeni Research Inc. founder Ed Yardeni. "There's a chance the Fed may shift its focus from price inflation to asset inflation.