(Bloomberg) -- Stock and bond investors who’ve spent months sneering at the Federal Reserve are starting to worry about a comeuppance.
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On the eve of a landmark gathering in Jackson Hole, Wyoming, a concern repeatedly voiced in interviews with big money managers is that market confidence itself is something the Jerome Powell-led bank is bent on doing away with.
Financial conditions -- going by measures of strain across asset classes -- are at easier levels than before the Fed kicked off its most aggressive tightening campaign in decades back in March, according to a Bloomberg gauge. By Powell’s own admission, that’s a problem for policy makers, who are monitoring whether these drivers and strictures on the real economy are “appropriately tight” as they battle to cool inflation.
“The Fed needs to break one of two things,” said Gene Tannuzzo, global head of fixed income at Columbia Threadneedle. “Either they need to break the labor market, with unemployment pushing higher. Or they need to break financial conditions.”
Even with this week’s shudder, stocks and Treasuries have rebounded mightily from June’s lows. Corporate bonds have rallied as well, with spreads on both investment-grade and high-yield debt far narrower than July’s peaks.
The S&P 500 finished 1.4% higher on Thursday, its biggest jump in almost two weeks, while yields on 10-year Treasuries fell 7 basis points to just above 3%.
That’s all served to ease financial conditions as policy makers try and beat back market pricing of a friendlier Fed in the face of still decades-high inflation. Earlier this week, Federal Reserve Bank of Minneapolis President Neel Kashkari said it’s “very clear” the Fed needs to continue tightening. On Wednesday alone, both Kansas City Fed President Esther George and Philadelphia Fed President Patrick Harker said rates need to be lifted into restrictive territory.
“I don’t think the market’s listened to any of the governors,” Tom Thornton, Hedge Fund Telemetry Founder, said in a Bloomberg Television interview. “It’s going to take Powell to reverse some of the dovish comments he had at the last Fed meeting to have the market take this seriously.”
Minutes of the Fed’s meeting last month stoked a view that the Fed might soon pivot to a less-aggressive stance. After several consecutive super-sized hikes, the pace of rate increases could slow “at some point,” the minutes showed.
But even if policy makers back off from another 75-basis point hike at September’s meeting, quantitative tightening is scheduled to kick into its highest gear. The balance-sheet runoff’s monthly cap will lift from $47.5 billion to a maximum pace of $95 billion next month -- a reality that has yet to be reflected in markets.
“Here we are with a Fed that’s going to want to reduce the size of its balance sheet, it wants to soak up excess liquidity, and as that happens, markets are doing exactly the opposite,” Karissa McDonough, Community Bank Trust Services fixed-income strategist, said in a Bloomberg Television interview. “They are going to do whatever they can to put a fork in it.”
The potential for a marketwide shock is high. A Barclays Plc measure of cross-asset correlation is hovering near the highest levels of the past 17 years, with everything from equities to bonds to commodities moving seemingly in lockstep.
The current macro-obsession across markets puts the focus squarely on Powell’s performance Friday. Given that the annual Jackson Hole symposium is such a high-profile event, the Fed Chair would be seen as endorsing the easing seen in financial conditions if he doesn’t comment on it, according to LH Meyer’s Derek Tang.
“The Fed really needs to convince the market that you are not taking us seriously enough -- we are saying all these things and you are not believing us,” said Tang, an economist at LH Meyer in Washington. “People are want a comment from Powell on it. And if he doesn’t, it’s sort of silence speaks volumes.”
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