It’s funny, the success or failure of today’s Fed announcement and Chairman Powell’s press conference will be determined by how the stock market reacts to it. If it rallies, today will be deemed a success by the Street…and if the market declines, it will be seen as failure. The problem with this thinking is that the consensus on Wall Street has come to believe that it’s the Fed’s job to try to keep the stock market rallying at all times. Of course, if you asked somebody directly, they’d answer differently…but subconsciously, most people expect the Fed to do whatever it takes to create a bull market for stocks and most other risk assets.
We cannot blame people for feeling this way. The “Fed put” meant that our central bank “had the back” of stock investors ever since the Great Financial crisis. However, most of them do not realize, the Fed really “had the back” of the financial system…not the stock market. After Ben Bernanke made the stock market a tool in impacting economy growth (instead of the market being an indicator of that growth…as it had been for decades), a severe decline in the stock market would have CAUSED the kind of stress in the financial system that would have put the system at risk. (As much as it seemed like everything was a-okay, the system remained extremely fragile for many years following the GFC.) Therefore, the Fed did indeed keep the market rallying for many, many years through several QE programs.
However, the Fed thought they could bring things back into equalibrium in 2018, so they started tightening policy. They did this so that they could get interest rates back in-line with where they should have been given the level of economic growth at the time. Even as the stock market fell into a deep correction, the Fed continued to raise rates. They knew that they needed to “normalize” interest rates…and they also KNEW that it would cause the stock market to decline…and fall back in-line with its underlying fundamentals. (Things were not “normal” in many markets for a decade leading into the end of 2018. They were helped by artificial stimulus.)
However, that “normalization” process ran into problems. The fixed income market suddenly saw some serious stress at the very end of 2018…especially in the high yield market. Therefore, the Fed was forced to “pivot”. They did NOT “pivot” because the stock market was falling…and they did NOT pivot because the economy was slowing in a significant way. They “pivoted” due to some serious stress showing up in the system. Therefore, the Fed had to step-back from their real goal at that time…which was to get the markets back in-line with their underlying fundamentals.
A couple of years later, the Fed had to save the system once again. This time, the crisis had to do with the almost complete shut-down of the global economy. This, in turn, led to the freezing up of the fixed income markets…which is the same thing as saying it was leading to a freezing up of our financial system. Therefore, they (and other central banks) flooded the system with liquidity once again…with the goal of saving the financial system (once again).
So, what’s the Fed’s real goal today? Well, a big part of is to get inflation under control…as they have been saying all year. However, another part of their goal today is to take away the massive levels of stimulus that they HAD to provide the system in 2020. If they do not remove that stimulus, it would create the kind of bubble that would be impossible to recover from once it eventually (and inevitably) burst…..Ever since the Fed engaged in this massive QE program, they have ALWAYS known that they would have to reverse it. They have also ALWAYS known that it would cause the stock market to fall in a significant way…AND that it would have a negative impact on the economy.
In other words, the Fed’s goal no longer involves “having investors’ backs.” Its goal is to get inflation under control…AND to remove the steroids from the markets…….In 2020, the Fed saved the financial system. In order to save the system, they caused the stock market (and other markets) to rally in a dramatic way…and to levels that were far above their underlying fundamentals. Today, the Fed is also working to save the system again. However, to do it THIS time, they have HAD to do things…and will CONTINUE to do things…that will actually hurt the stock market.
The Fed did not save the markets in 2008/09…and then again in 2020. They saved the financial system. Therefore, the Fed did not really “have the markets’ backs” over the last dozen years…they had the “financial system’s back.” In order to have the “financial system’s back” today, they have to keep inflation from getting out of control…and they have to prevent another 1999/2000 bubble from re-emerging.
This is a long-winded way of saying that even though most people on Wall Street will use the market’s action over the next few days to decide whether Mr. Powell and the Fed has been successful this week. However, we believe that Mr. Powell and his team at the Fed will have a much different view of how to measure the success of their policies.
Matthew J. Maley
Chief Market Strategist
Miller Tabak + Co., LLC
Founder, The Maley Report
275 Grove St. Suite 2-400
Newton, MA 02466
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