Does Market Accept Fed’s Transitory Narrative?

FS Insight Team

Well, we said that Jerome Powell has a good week and got a reprieve because of the ‘goldilocks’ numbers last week. We think maybe that this week he is even more pleased. Why? Because it appears the market is in quite a trusting mood with the Fed. Appearances can be deceiving. However, it is no doubt that the Fed’s immediate playbook was made easier by the fact that markets actually went up after a significantly hotter than expected CPI number. Rather than sell off, stocks closed at two successive ATHs back-to-back and rates remain subdued. It’s almost too quiet?

We did hear some rumblings that a some of the price action could have been due to a short squeeze in the bond market, but we’re not certain to what degree. There are compelling arguments on both sides of the ‘great inflation debate,’ but ultimately time will tell. We are living in an era where forecasts based on historical data are limited in significance and effectiveness given the absolutely novel character of our current economic situation. We don’t know what a post-pandemic economy will look like in a 21st century economy and how possibly could we?

The Fed announced recently that it will provide the public with results from its informative Dodd-Frank Act Stress Tests. These supervisory actions test the resilience of banks given a number of scenarios ranging from severely adverse to positive.

Though the supervisory function and monetary policy function are often considered separate the Fed’s thinking on the former (as read through its stress test scenarios) can sometimes be ascertained in the little details. If the Fed isn’t worried about financial stability, you’ll be able to tell in the severity of the adverse scenario as well as what the Fed considers its baseline for supervised institutions. We will give you a full breakdown of this informative tool and will also discuss the dot plot developments next week.

We did mention in the beginning of the pandemic that the interruption to income likely wouldn’t be as severe as during the financial crisis because the primary employment effects were felt in the lower quintiles this time around, many of whom had their income more than replaced by stimulus.

There is an upcoming Fed meeting in June and, as of the recent events, there is very little reason to believe that the Fed will make any significant changes. The most watched elements from the meeting will be the infamous “dot plot” which measures the anonymous estimates of respective Fed governors with regards to timing of any policy changes. It will be very interesting in this respect to see if the inflation data is motivating more Hawkish members to move their estimates up in time.

While the Fed may have gotten another temporary reprieve, pressure is building on it to respond to skyrocketing prices. Many economists are expressing concern that the Fed is falling behind and needs to begin discussing a wind-down of pandemic-era measures sooner rather than later.

Asset purchases continued at a pace of $40 billion a month for MBS and $80 billion a month for Treasuries. The benchmark yield on the 10 year is at an even tamer 1.454% than last week.

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