Market professionals are supposed to be the ones warning the Fed to "go it slow," "don't break things," etc., but the chorus of investors begging the Fed to tighten even further right now is growing.
Take hedge fund manager Bill Ackman, who yesterday tweeted, "The [Fed] has allowed inflation to get out of control. Equity and credit markets have therefore lost confidence in the Fed. Market confidence can be restored if the Fed takes aggressive action with 75 bps [rate hikes] tomorrow and in July, and a commitment to continued [tightening] until it is clear that inflation has been tamed."
He added, "And yes, 100 bps tomorrow, in July and thereafter would be better. The sooner the [Fed] can get to a terminal FF rate and thereafter can begin to ease, the sooner the markets can recover."
By "terminal rate," Ackman means the level of neutral--or even restrictive--interest rates that is needed to dramatically slow inflation. And the market has had to quickly rethink how high rates need to go because inflation remains so elevated; it now thinks the Fed has to take rates to 4% by the middle of next year, from their current 0.75% to 1% range. Ackman is saying, why not get there--or to at least 2-3%--as quickly as possible.
Jeffrey Gundlach, of DoubleLine, made a similar remark last night, tweeting, "The Federal Reserve should raise the Fed Funds rate to 3% tomorrow, in my opinion." Again, this is someone who has seen plenty of financial market crises first-hand. He knows how bad liquidity already is in the markets. And he knows the Fed erring on the side of "caution" could actually make things a lot worse right now.
A friend of mine with a long career in markets made a similar comment to me over the weekend. "Markets prefer the devil they know over the devil they don't," he said. "An aggressively tightening Fed is a better known commodity than rampant inflation." I asked, would markets freak out if Powell took the kind of measures Ackman, Gundlach, and others are calling for? "Actually, if they did that, equities would massively rally," he replied, "and forward inflation breakevens would collapse."
Should weaker economic data give the Fed pause right now? Not necessarily. Yes, retail sales dropped this morning. Yes, the Empire Fed regional manufacturing index was weak. But investors are basically chalking up this business cycle as a loss already; far better to shorten it now, conquer inflation, and have a faster, more promising recovery than to let these problems linger chronically, is what they're saying.
After all, the deep Volcker recession of 1981-82 was the worst postwar drop since the Great Depression; but as inflation finally ebbed, it was followed by such a strong recovery that President Reagan was reelected with the biggest electoral college landslide ever by 1984. A similarly sharp downturn now might not spare President Biden a midterm loss, but it could set up much more promisingly for his 2024 reelection than a years-long period of stagflation.
Monetary policy, remember, works with "long and variable lags." Even the most aggressive tightening today will take a year or more to work through the economy. Waiting another year to get aggressive only delays the timeframe further. And at least our Fed has the ability to tighten considerably right now--the same can't necessarily be said for Europe or Japan, leaving us, as is so often the case, as the biggest available player to tame global inflationary pressures.
Indeed, Europe had to call an "ad hoc" (i.e. emergency) central bank meeting this morning to reassure markets that as yields of slower-growth economies start to jump in response to less central bank bond purchases, they remain committed to "act against resurgent fragmentation risks." This for the region that also has the worst inflation because of soaring energy prices; thankfully the U.S. is more insulated thanks to our larger domestic energy industry.
So yes, markets have had to digest a lot already this year. But that's pushed the Fed much closer to an appropriately tight monetary policy. To give up or pause now would feel to markets a bit like that famous Tennessee Titans Super Bowl where they came up just one yard short of a touchdown and lost the game in the final moments.
"We are much closer to pricing in a realistic tightening path now than we were a few weeks or months ago," wrote MKM's Michael Darda yesterday. If the Fed "actually pulls the trigger," on market expectations of a 75-basis-point hike today, and similar future tightening, he said, it could mean "the collapse in equity valuations may be (mostly) behind us now."
See you at 1 p.m!
Kelly