Federal Reserve has given short sellers reason to push markets lower, Wells Fargo says

Published Mon, Oct 3 202210:40 AM EDT

The Federal Reserve has inadvertently given short sellers the all-clear signal to pummel markets, according to Wells Fargo equity analysts led by Christopher Harvey. Stocks have been in freefall since Federal Reserve Chairman Jerome Powell delivered the message in late August that interest rates need to rise until there is " pain " felt in the U.S. economy. That message has rippled around the world in recent trading sessions, as a surging dollar threatens to destabilize the currencies and bonds of other countries. Last week, the Bank of England was forced to prop up the market for its sovereign debt. "What is troubling is the apparent downplaying of capital market signals as the Fed trudges toward its 2% inflation target," Harvey said in a note published Sunday. "Therefore, those signals will need to get louder (i.e. even lower equities and wider spreads) before the Fed reacts." As cracks begin to form in global markets for currencies and bonds, analysts and investors are increasingly calling for the Fed to consider pausing its campaign to raise interest rates further. While many point to the impact that the Fed's aggressive rate increases have had on the dollar, the Wells Fargo analysts point to another dynamic: The impact the Fed is having on investor psychology. "Many investors interpret the Fed's statements to mean that it will not rescue capital markets until something breaks, meaning investors will keep pushing until something does break," Harvey said. Dog whistle to shorts "The messaging is a `dog whistle' to short-sellers that want to lean into the market," he said. A dog whistle is a message that can only be understood by a particular subset of listeners. While the analysts didn't identify the types of short sellers it was referring to, they would typically include large hedge funds. Investors believe the so-called Fed put, or the point at which the central bank of the world's biggest economy intervenes to support markets, is a relatively distant prospect, according to the analysts. That has helped sow "instability across capital markets" and implies that a future recession will be worse than expected. The "Fed might help themselves by acknowledging the troubling capital market trends both here and abroad," Harvey said. As for investment advice, the analysts believe the current market rewards stocks with good long-term price momentum. Investors should use any market bounces to sell low-momentum stocks and boost exposure to high momentum names, they said. The strategy "typically outperforms in stressful times by keeping investors away from adverse stock situations," Harvey said. "In simplest terms, it is a `chart-looks-good/bad' market." High momentum names include Electronic Arts, Autozone , General Mills , Marathon Petroleum , M & T Bank , and Cardinal Health . With CNBC's Michael Bloom