Stocks softened as two US Federal Reserve presidents spoke of the need for “rapid” balance sheet adjustment.
This was not news, but it seems the Fed thinks it is a new idea to hasten the process. It has been clear for some time that the Fed is well behind the curve on both interest rates and the nature of its balance sheet.
What was interesting was the hint of panic in yesterday’s two separate comments. Suggesting Chairman Powell may be seen as a touch stubborn or slow on both policy adjustments by other members of the committee?
The next FOMC should see faster balance sheet reduction at last, and higher rates of course. Both policy shifts do need to be accelerated.
This was enough on the day to see some of the recent steam come out of equity markets. Still, it should be noted that even with an aggressive rate hike cycle, it will take a long time to get back to a neutral level.
In the meantime, US rates continue to be highly stimulatory. Equity markets, therefore, are concerned about the Fed raising rates but see no need for any real panic yet.
While balance sheet adjustment was the catalyst on the day, there are bigger issues to consider. We remain of the view that stocks generally are defying gravity and probably belong to 10% to 20% lower at some point this year. Due to Ukraine, European, and possibly US recessions, as well as significant supply chain disruption and inflation.
As we mentioned yesterday, it was time to focus on the Euro.
The view here is that the Ukraine conflict, disruption, impact on consumer sentiment and inflation all lead to a significant European recession. Which the Euro itself has yet to fully price. This is because some intervention and liquidity provision by the ECB was appropriate in the early stages of the war.
However, the ECB was never going to draw a line in the sand. As the war drags on and there is renewed talk of further sanctions, fresh selling pressure will emerge to send the currency lower.
We expect to see a sub-parity Euro, toward .9700, by year’s end.
Market insights and analysis from Clifford Bennett, Chief Economist at ACY Securities
