Pro Perspectives 5/23/22

May 23, 2022

We entered the year with household net worth on record highs. 
The job market was tight.  Consumers and businesses were flush with cash.  And residential real estate valuations were on record highs. 
Add in a record high stock market and ultra low interest rates, and we had a recipe for hot consumption.
That was the top.  
The high for the year in stocks was January 4th.  On Friday, we hit "technical bear market" territory for the S&P 500.  That's down 20%. 
What changed?
Was it war in eastern Europe?  Was it domestic policy mistakes?  Was it inflation? 
None of the above (not even oil). 
It was the Fed. 
Sure, the Fed is reacting to inflation.  But they could have executed a campaign to get inflation under control, by stepping UP interest rates.  They probably could have even done an emergency meeting rate hike to take the Fed funds rate back to neutral (around 3%), in one fell swoop.
And the economy, and the stock market, would have probably (still) boomed, at least until the Fed was seen to be clearly charging down the path of restrictive monetary policy (i.e. projecting as if they might move rates toward or above the inflation rate).  And that could have been by late this year, or early next year.  In that case, the Fed would have been putting the brakes on a very hot economy.  
Instead, the Fed opted against a traditional rate tightening campaign, and they opted for launching an attack on demand.  
The easiest way to take the air out of demand?  Crush the stock market.
The easiest way to crush the stock market?  Tell consumers, businesses and investors that you're going to attack demand. They will sell stocks.
That's precisely what the Fed did.  Jay Powell said explicitly back in March that they were trying to better align demand with supply (i.e. bring demand down).
With all of the above in mind, we talked last week about the Fed's "forward guidance" game.  This is how they talk their desired effect into existence, without having to take any big policy action.
Ben Bernanke (the former Fed chair) gave a presentation today at the Brookings Institution, where he said just that:  "Monetary policy is 98% talk and 2% action."  Their talk, at the moment, is intended to deflate stock prices, deflate animal spirits, and deflate demand.  That mission is being accomplished.