Powell May Not Know It Yet, But The Fed Is Now Trapped

Bank of America continued:

If Fed Funds target rates of 2.00-2.50% are enough to cause the economy to go into recession, with inflation having normalised at around 2%, then potential growth would seem to be less than 50bp. Alternatively, when looking at where the USD OIS curve regains positive shape and flattens out (in the 7-10 year forwards) the market price for neutral rates again seems to be as low as 2.00-2.50%, leading to the same conclusion. If the above were true, every asset bar rates is massively mispriced.

And the punchline: "If we accept market pricing, then there is no shortage of inconsistencies to take advantage of. If the world is going into a severe slowdown, then the Fed is unlikely to wait until next year to cut rate."

What this means stated simply, is that while stocks may be rejoicing that the Fed shifted from hawkish to dovish, this may prove dangerously near-sighted, especially if the Fed is indeed concerned about a major recession breaking out, an outcome which will have devastating consequences once the current short squeeze ends as does the vicious snapback bear market rally, and stocks resume pricing in a global contraction.

All of this brings us to a note from Citi's Jeremy Hale, who like Morgan Stanley, agrees that while equities may indeed need Fed help, it is indeed the question whether the Fed will help, and frames the response as follows: "Maybe if the equity market portends weakness in the economy. Does it?"

And this is where we find why the Fed is now trapped, at least when it comes to the Fed's reaction function... and the market's response to the Fed's response.

The problem is simple: for the Fed, the sequence of events during past recessions has been: Fed cuts, the SPX crashes, Fed cuts. So, as Citi notes, the SPX crash is a symptom of greater economic weakness rather than the cause.

Of course, it's a bit more nuanced than this, because as Citi also shows, for all three slowdown periods the sequence of events is: Fed hikes, equity market crashes, Fed cuts.

View single page >> |

Disclosure: Copyright ©2009-2018 ZeroHedge.com/ABC Media, LTD; All Rights Reserved. Zero Hedge is intended for Mature Audiences. Familiarize yourself with our legal and use policies every time ...

more
How did you like this article? Let us know so we can better customize your reading experience. Users' ratings are only visible to themselves.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.