Why the new bull market is headed for more Fed stress after a break

- Stocks and bond markets are betting the Federal Reserve will halt its rate hikes, the most aggressive monetary policy since the 1980s, at this week’s meeting of the Federal Open Market Committee.
- Former Fed Deputy Chairman Roger Ferguson told CNBC that he believes the Fed decision is a much closer call than the market expects, and what will come after that will be more central bank hikes to tame inflation.
- Investors should prepare for a Fed “that is going to continue to wander,”[ads1]; he says.
Traders are signaling that a pause in rate hikes is the most likely outcome of this week’s Federal Open Market Committee meeting at the Federal Reserve, and it comes at a time when some strategists say a new bull market is underway. The Dow Jones Industrial Average posted three consecutive winning sessions to end last week, the NASDAQ Composite saw its sixth consecutive positive week for the first time since November 2019, and all major indexes closed above their 50-day and 200-day moving averages. average on Friday.
“The bear market is officially over,” Bank of America equity strategist Savita Subramanian said recently, noting that the S&P 500 is up 20% from its October 2022 low.
Some are questioning the new bull market rally based on how narrow market leadership has been — a handful of the biggest tech stocks responsible for much of the rally in market indexes. But there is another important reason why investors should not get overconfident. Even if the Federal Reserve decides to pause when it announces its latest FOMC decision on Wednesday, a longer lasting shift from the Fed into its most aggressive period of monetary policy since the 1980s is by no means certain or warranted.
That’s what former deputy chairman of the Federal Reserve, Roger Ferguson, says.
Last month, the Fed approved its tenth rate hike in just over a year, the fastest monetary policy tightening by the central bank since the 1980s, with significant consequences not only for stock and bond markets, but for the economy and consumers. . In its May FOMC meeting statement, the Fed removed language about the need for “further policy tightening” to meet inflation targets. That helped maintain the majority view in the market that a pause will be announced this week.
But Ferguson is still not convinced.
“I think the pause here is really a closer call than the market is currently expecting,” he said in an interview with CNBC’s “Squawk Box” on Friday. And even if the Fed takes a break, Ferguson says that doesn’t mean there won’t be more rate hikes for the rest of the year.
“The market should prepare for a Fed that is going to continue to wander even if this happens to be a pause,” Ferguson said.
He is not alone in believing that a Fed pause will not last long. “We think the Fed will end up skipping this month, but setting the table for actions in July,” Michelle Girard, head of the U.S. at NatWest Markets, said in an interview with CNBC senior economics reporter Steve Liesman last week.
A pause is highly likely, according to former Atlanta Fed President Dennis Lockhart. However, he noted in an interview with CNBC’s “Closing Bell Overtime” that inflation will continue to pose a problem for the Fed. “There are some understandable signs of falling inflation, but it’s very gradual. I think the committee still has a big challenge, especially with a 2% target,” Lockhart said, referring to the Fed’s stated goal of bringing inflation back down to a target range of 2% in the longer term.
On an annual basis, the inflation rate was 4.9% in April, slightly below market estimates, but it remains “sticky,” both as observed in economy-wide prices and in the expectations of many CEOs who say inflation will persist. This coming week will include the latest reading on the annual and monthly inflation trend with the May Consumer Price Index report due on Tuesday, the first day of the Fed’s two-day FOMC meeting.
Traders react as Federal Reserve Chairman Jerome Powell is seen making comments on a monitor, on the floor of the New York Stock Exchange (NYSE), May 3, 2023.
Brendan McDermid | Reuters
Ongoing inflation concerns are one of the factors leading Ferguson to see a greater possibility of a rise on Tuesday. This view is underpinned, among other things, by a labor market that is still tight. Wage growth has cooled, and unemployment is increasing. But Ferguson cited about 1.7-1.8 jobs for every unemployed person, far higher than the norm; and wages that have continued to rise, not only in the latest national data, but also relative to what he hears anecdotally from CEOs — Ferguson sits on the boards of several major companies, including Alphabet and Corning.
“I think overall the picture is one of inflation and inflationary pressures that are higher and stickier than the 2% that the Fed has been aiming for. So I think it’s the data that’s already here that tells us more hikes are on the way.” he said.
Others see the recent cooling of the labor market as a signal that the Fed may soon have more need to moderate its rate hike strategy. Wharton professor Jeremy Siegel recently told CNBC that while the Fed has expressed a strong commitment to lowering inflation, the central bank’s dual mandate is achieving its inflation rate and promoting maximum employment. On a historical basis, unemployment remains extremely low – below 4% – but jobless claims recently reached their highest level since October 2021.
“I’m talking about trend here,” Siegel said.
For now, the Fed can be “as aggressive and hawkish as they are,” Siegel said, because there hasn’t been much of an uptick in unemployment and workers continue to feel confident about their labor market prospects. There are some signs that confidence in workers is on the decline. The latest Consumer Confidence Index from the Conference Board showed that consumers’ assessment of current employment conditions experienced “the most significant deterioration” in May among the consumer sentiment data it tracks. Labor economists have told CNBC that the latest labor market data supports Fed Chair Jerome Powell’s view that the central bank can engineer a soft landing for the economy.
“There’s nothing here that makes me think we’re not in a soft-landing scenario,” said Rucha Vankudre, senior economist at labor market consultancy Lightcast in a recent interview after the May nonfarm payrolls report. “I wouldn’t be surprised if the Fed decides to keep interest rates where they are. All indicators point to the economy moving in the right direction.”
Nick Bunker, director of economic research at Indeed Hiring Lab, says all of the latest data points are broadly in line with the soft landing hypothesis. “The broad picture here is that the labor market is cooling in a sustainable way. There are signs of moderation and not a ton of red flags,” Bunker said.
But there’s an old saying on Wall Street that the labor market is always the last to know when a recession hits.
“Let me say one thing,” Siegel told CNBC. “If we get a negative jobs report in the next month, the next two months, it’s going to make headlines, the first time since Covid. And then people are going to say, ‘Oh, I can be sure I’m going to to get another job?’ And that’s going to play into policy, and I think that’s going to push the Fed on the other side, and then they’re going to start saying, ‘Okay, maybe inflation is going to get better.
Goldman Sachs recently lowered its house view on the odds of the US economy entering a recession, but its own CEO David Solomon – who remains convinced that higher inflation will be persistent – and Ferguson remain uncertain about how future Fed decisions will shape the economic outlook. Solomon said at the recent CNBC CEO Council Summit that “some structural things that are happening” related to inflation will make it difficult to “easily” get back to the Fed’s 2% target, and even if the Fed stops, based on what he sees now in the economy, there is no expectation of an interest rate cut by the end of the year – a result that bond traders have bet on.
Ferguson fears that high inflation levels could force the Fed to raise interest rates to a level that effectively forces the US into a recession. “I’m still in the camp that recession is a real possibility. Short and shallow one hopes, but you know, let’s see, and let’s hope Goldman is right,” Ferguson said.
Former Fed Governor Frederic Mishkin shares the concerns about inflation, and believes that the correct Fed course is not to take a break in June.
“I can understand why [the Fed] maybe will [pause]it’s not terrible if they do,” Mishkin said in a recent CNBC interview. “But I think we’re in a situation where inflation numbers are still high, very slowly coming down toward the 2% target.”
Mishkin is more concerned, he said, about underlying inflation, which is a number that is reliable in predicting what the future path of inflation will be. “The economy and the labor market are still strong, there is some weakening, but we have a long way to go before we contain inflationary pressures, and so I think the Fed is going to have to raise interest rates, and it’s better to do it now. to show their strong commitment to keeping inflation under control,” he said.
A pause is unlikely to do significant damage to the economy, even if subsequent rate hikes are necessary, Ferguson said, pointing to examples of “early pauses” — the Bank of Canada and the Reserve Bank of Australia. “Both took a break and have now returned to a tour process,” he said.