Stock selloff is far from forcing the Fed to blink
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[January 27, 2022] By
David Randall and Tommy Wilkes
NEW YORK/LONDON (Reuters) -Those clinging
to a decade-old belief that the Fed will mount a rescue of tanking stock
markets with a last-minute pushback on the timing of interest rate hikes
may be left disappointed.
Equities have nosedived and government bond yields have risen in the
runup to Wednesday afternoon's Federal Reserve policy decision
https://www.reuters.com/business/
finance/inflation-fighting-fed-likely-flag-march-interest-rate-hike-2022-01-26,
which is widely expected to signal an interest rate liftoff in March and
the timing of stimulus cutbacks.
While the rout has since eased, it raised the question: how much pain
must stock markets endure before the Fed backstop - or "put" - comes
into play? And has that estimate changed?
Named for the hedging derivative used to protect against market falls,
the "put" was deployed during previous selloffs, most recently in early
2019 when a market tantrum persuaded the Fed to call time on its rate
hiking cycle.
Now after years of easy-money polices, stakes are high. A trillion
dollars flooded into global stocks last year, surpassing the combined
total of the past 19 years, and U.S. stocks have doubled in value since
March 2020.
Based on history, Julian Emanuel at Evercore ISI Research reckons the
S&P 500 would need to fall by 23.8% from its recent high for the central
bank to act. Janus Henderson Investors estimates the put kicks in when
declines surpass 15%.
![](http://archives.lincolndailynews.com/2022/Jan/27/images/ads/current/graue_21BLAZER_081621.png)
But this time, the need to stamp out inflation running at 40-year highs
around 7% may change the equation.
"The Fed will typically only let the risk markets to sell off so much
before they feel the need to slow it down a little bit. But now we have
to ask, will they allow it go down 20%? Twenty-five percent?" said Jason
England, global bonds portfolio manager at Janus Henderson.
"It's new territory."
While a rebound is now under way, year-to-date losses
https://www.msn.com/en-ca/money/topstories/analysis-fed-tightening-a-sign-to-get-the-
heck-out-of-us-stocks/ar-AATaxxg amount to 9% and 12% for the S&P 500
and Nasdaq, respectively.
Holding off tightening also raises risks the Fed might have to hike more
should inflation get out of control. And it would go against
policymakers' view that the economy has recovered faster than
anticipated.
"The Fed ... because of the current inflation backdrop is not going to
be able to blink. That's an issue markets are going to have to deal
with," Morgan Stanley strategist Graham Secker said.
FINANCIAL CONDITIONS
Equity selloffs matter to policymakers because they can tighten
financial conditions, in turn impacting the spending, saving and
investment plans of businesses and households.
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![](../images/012722pics/busine51.jpg)
The Federal Reserve building is seen before the Federal Reserve
board is expected to signal plans to raise interest rates in March
as it focuses on fighting inflation in Washington, U.S., January 26,
2022. REUTERS/Joshua Roberts
![](http://archives.lincolndailynews.com/2022/Jan/27/images/ads/current/lincolnheating_lda_LUAL_2021.png)
Though the Fed’s dual mandates of maximum employment and stable prices do not
take into account market swings, research
https://www.nber.org/system/files/
working_papers/
w26894/w26894.pdf showed the central bank is sensitive to equity weakness, with
policymakers’ negative stock market mentions associated with cuts in the fed
funds rate.
Indexes compiled by Goldman Sachs and the Fed imply conditions are indeed
tightening, but from historically loose levels.
Metrics that feed in to these indexes do not show much stress. While sovereign
bond yields have risen - U.S. two and 10-year yields are at pre-pandemic levels
- moves are less stark once inflation is stripped out.
Both U.S. and German 10-year "real" yields remain below where they were for much
of 2021 and 2020.
And yield premia on junk-rated credit, normally vulnerable to stock market
falls, remain well below year-ago levels. U.S. corporate credit spreads remain
low versus pre-pandemic levels.
"If you want to be bearish you could say the selloff has not done very much to
tighten financial conditions," Morgan Stanley's Secker said.
There is, however, another view. Whereas once policymakers ignored share prices
and focused on corporate borrowing costs, some investors today believe that
"markets drive economies," making it much harder for policymakers to stomach
significant stock selloffs.
Michael Howell at consultancy CrossBorder Capital said conditions were
tightening faster than many measures capture.
Oil prices have risen, central banks have slowed the rate of money growth
injected into economies and on a quarterly basis money supply is shrinking,
Howell noted.
"A 10% drop in the markets would be OK, much more than that they may 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 bps hike in March, which some investors have
predicted.
![](http://archives.lincolndailynews.com/2022/Jan/27/images/ads/current/ldn_sda_062409.png)
But, he said, the Fed will proceed with hikes "until something breaks," adding,
"it's far too soon in the process for the Fed to be dissuaded by equity investor
anxiety."
(Reporting by David Randall in New York and Tommy Wilkes in LondonAdditional
reporting by Dhara Ranasinghe and Saikat Chatterjee in LondonEdited by Sujata
Rao and Matthew Lewis)
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