Stock rebound is Powell’s headache as financial terms ease

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(Bloomberg) — A rebound in risky assets could prove a problem for a Federal Reserve trying to curb excesses in the markets.

Equities have risen sharply since mid-May lows and credit spreads have narrowed to levels seen prior to the launch of rate hikes in March, while the Bloomberg Dollar Spot Index has cooled from the two-year high it reached earlier this month. All things considered, a Bloomberg measure of US financial condition — a cross-asset measure of market health — has returned to pre-March levels.

This may pose a problem for policy makers. Fed chief Jerome Powell has repeatedly said financial conditions will deteriorate if the central bank withdraws monetary support to combat the highest inflation rate in four decades. If price pressures build and growth remains robust as markets continue to climb, the Fed may need to tighten the reins even more, said 22V Research founder Dennis DeBusschere.

“The mechanism by which the Fed influences the real economy is through the financial conditions channel,” DeBusschere told Bloomberg Television. “If the data does not slow down, financial conditions will have to be tightened further.”

The easing of conditions follows a week in which virtually everything from speculative to blue chip stocks rose as traders scaled back expectations for rate hikes, fueling a decline in government bond yields. The broke its longest weekly losing streak in a decade en route to its biggest rally since 2020, while a basket of unprofitable tech stocks ended a seven-week decline.

To strategists at Morgan Stanley (NYSE: ), last week’s jump in stocks is little more than a hiccup amid a broader decline, especially with a Fed eager to cool demand.

“The more stock prices rise, the more aggressive the Fed will be,” Morgan Stanley’s Michael Wilson wrote in a report on Tuesday. “Investors may be underestimating the Fed’s willingness to shock the markets if it needs to to meet its inflation targets.”

©2022 Bloomberg LP



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