Analysis: Selling stocks is far from forcing the Fed to blink


The Federal Reserve Building is seen ahead of the Federal Reserve Board signaling its intention to raise interest rates in March as it focuses on tackling inflation in Washington, States United, January 26, 2022. REUTERS / Joshua Roberts

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NEW YORK/LONDON, Jan 26 (Reuters) – Those clinging to a decade-old belief that the Fed will stage a bailout of collapsing stock markets with a last-minute rollback on the timing of interest rate hikes interest could be disappointed.

Stocks plunged and government bond yields rose ahead of Wednesday afternoon’s Federal Reserve policy decision, which is widely expected to signal a March interest rate hike and the timing of cuts. of the revival.

While the rout has since eased, it has raised the question: How much pain do stock markets have to endure before the Fed’s backstop – or “put” – kicks in? And has that estimate changed?

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Named after the hedging derivative used to protect against market falls, the “put” has been deployed in previous sell-offs, most recently in early 2019 when a market crisis persuaded the Fed to suspend its rate hike cycle.

Today, after years of easy money politics, the stakes are high. A trillion dollars flooded global stocks last year, surpassing the combined total of the past 19 years, and US stocks have doubled in value since March 2020.

Based on history, Julian Emanuel of Evercore ISI Research estimates that the S&P 500 would need to fall 23.8% from its recent peak for the central bank to act. Janus Henderson Investors believes that the put option kicks in when declines exceed 15%.

But this time, the need to eradicate inflation, which is reaching 40-year highs around 7%, could change the equation.

“The Fed will usually only let risky markets sell off that much before they feel the need to slow it down a bit. But now we have to ask ourselves, are they going to allow it to fall 20%? Twenty- five percent?” said Jason England, global bond portfolio manager at Janus Henderson.

“It’s new territory.”

While a rebound is underway, losses since the beginning of the year are 9% and 12% for the S&P 500 (.SPX) and the Nasdaq (.IXIC), respectively.

Delaying tightening also increases the risks that the Fed will have to hike further if inflation spirals out of control. And that would run counter to policymakers’ view that the economy has recovered faster than expected.

“The Fed…given the current inflationary backdrop won’t be able to blink. That’s a problem markets are going to have to deal with,” said Morgan Stanley strategist Graham Secker.


Equity sales are important for policymakers because they can tighten financial conditions, which impacts the spending, saving and investment plans of businesses and households.

Although the Fed’s dual mandates of maximum employment and price stability do not account for market fluctuations, to research showed that the central bank is sensitive to weakness in equities, with negative stock market mentions from policymakers being associated with cuts in the federal funds rate.

Indexes compiled by Goldman Sachs and the Fed imply that conditions are indeed tightening, but from historically loose levels.

Reuters Charts

The metrics that feed these indexes don’t show much stress. While sovereign bond yields have risen – US 2- and 10-year yields are at pre-pandemic levels – the moves are less marked once inflation is eliminated.

US and German 10-year “real” yields remain lower than they were for much of 2021 and 2020.

yield chart

And yield premiums on junk-rated credits, normally vulnerable to stock market declines, remain well below levels of a year ago (.MERH0A0). US corporate credit spreads remain low compared to pre-pandemic levels.

“If you want to be bearish, you could say that the sell-off did little to tighten financial conditions,” Morgan Stanley’s Secker said.

US Corporate Credit Spreads

There is, however, another point of view. Where policymakers once ignored stock prices and focused on corporate borrowing costs, some investors now believe that “markets drive economies,” making it much harder for policymakers to support massive stock sales.

Michael Howell of consultancy CrossBorder Capital said conditions were tightening faster than many metrics capture.

Oil prices have risen, central banks have slowed the rate of money growth injected into economies and, on a quarterly basis, the money supply is shrinking, Howell noted.

“A 10% drop in the markets would be acceptable, much more than that they might find it very difficult,” he said.

Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets, said stock market “fragility” ruled out a 50 basis point rise in March, which some investors had predicted.

But, he said, the Fed will hike “until something breaks,” adding that “it is far too early in the process for the Fed to be deterred by investor anxiety. in action”.

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Reporting by David Randall in New York and Tommy Wilkes in London Additional reporting by Dhara Ranasinghe and Saikat Chatterjee in London Editing by Sujata Rao and Matthew Lewis

Our standards: The Thomson Reuters Trust Principles.


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