While the sharp sell-off in stocks this year may feel brutal, especially after the September carnage, the S&P 500 remains about 17.1% above the end-2019 level, according to Dow Jones Market Data.
That’s not low enough given the likely magnitude of the Federal Reserve’s actions needed to bring rising inflation back to the central bank’s annual target of 2%, according to Steven Blitz, chief US economist at TS Lombard. .
“Yes, markets are being routed, but to date they are resetting from too high price levels created by the Fed’s policies that have lasted far too long,” Blitz said in a recent client note.
“As a result, the financial conditions are becoming tighter, but are not yet sufficient to
justify the concerns that the economy is about to blow a gasket.”
Blitz pointed out how little financial conditions have tightened (see chart) compared to past recessions, to bolster his case for why the Fed should still raise its key rate by more than expected.
US stocks ended lower in choppy trading on Wednesday, after a strong rally to start October and after their worst September since 2002. William Watts wrote how after a hard September, the S&P 500’s SPX,
typically sees modest gains a month later, but not the Dow Jones Industrial Average, DJIA,
when viewing historical data.
The biggest problem for Blitz is that the stock market decline this year has “barely been a shakeout” when looking at the roughly 50% drop in stocks during the 1974-75 and 2008-09 recessions.
“More to the point, the market has come here by pricing in the Fed’s 4.5% solution (4.5% inflation, 4.5% unemployment, 4.5% fund rate) and everyone believes this
will be enough to exert maximum downward pressure on inflation,” said Blitz. “It will not.”
Investors have focused on Friday’s September jobs report for clues as to whether the Fed could maintain the pace of excessive rate hikes in the face of robust wage increases that have fueled inflation.
RelatedSeptember: US jobs report saw hiring and job creation fall to a 1 1/2 year low
Instead, Blitz estimates that the Fed’s “solution” may need to reach 5.5%, especially as household balance sheets remain resilient so far, even as interest rates have risen dramatically, cooling the housing market as the 30-year mark year fixed mortgage rate is almost 7. %.
Energy costs as part of inflation came back into the picture on Wednesday as crude oil prices rose after major oil producers agreed to cut their collective crude production levels by 2 million barrels per day starting next month.
The decision was followed by US benchmark West Texas Intermediate crude for November delivery CLX22,
up 1.4% gain at $87.76 a barrel.
U.S. crude oil prices have fallen from an intraday peak in March of nearly $130 a barrel, according to FactSet data, after soaring as global economies first emerged from pandemic lockdowns, as well as transitioning to greener ones. energy resources and the Russian war in Ukraine.
Read: Why housing has ‘a lot of wiggle room’ in a recession, even if prices fall by 15%
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