“If You Need Money You Can Get It” – ‘Easy’ Market Crushes Fed’s Credit-Tightening Efforts

Fed Chair Powell knows he has a problem… and he all but admitted it this week.

He told journalists that “if financial conditions get looser we [may] need to do more”, but said he was confident interest rates were affecting economic activity and inflation.

“What tends to happen is financial conditions get in and out of alignment with what we’re doing [but] ultimately over time we get where we need to go.”

The problem – of course – is that he is full of gaslighting crap.

Soaring stock prices and falling bond yields have made it so much easier for US companies to raise funds than would be expected given The Fed’s inflation-fighting efforts so far.

In fact, as The FT reports, much of the impact of the Fed’s interest rate rises has been neutralised.

Goldman’s Financial Conditions Index is at its ‘easiest’ since The Fed started on its 50bps rate-hikes in May 2022, and while they have continued to hike rates for the last 9 months, financial conditions have done nothing but ease as traders ‘fight The Fed’.

Source: Bloomberg

Remember, looser financial conditions run counter to the Fed’s goal of slowing the economy to bring inflation under control, and make it more likely the Fed will have to keep interest rates higher for longer.

“The reality is that financial conditions have loosened — we have [effectively] unwound roughly 450 basis points of rate hikes. Financial conditions are enough to take us back to March of last year,” said Sonal Desai, chief investment officer for Franklin Templeton Fixed Income.

“As the market comes around to the belief that we are not going to have a recession, that implies that demand will remain strong, [and] that implies that we will not have any need to cut interest rates.”

The looser conditions reflect a view among investors that the Fed has effectively finished raising interest rates since its main focus is bringing down inflation – which has fallen sharply in recent months.

“I would say that conditions right now are loosening, probably to the chagrin of the Fed,” said Andy Brenner, head of international fixed income at Natalliance Securities.

“But as long as the Fed gets better inflation numbers, they’re going to care less and less.”

However, what few seem to believe is that inflation could re-emerge from these ‘easy’ financial conditions.

Mike Chang, a high-yield portfolio manager at Vanguard, said financial conditions had not loosened across the board.

“The market is still discriminating between stronger and weaker issuers and many weaker issuers still don’t have access to capital markets.”

“Higher interest rates generally take time to work [their] way through the economy and through corporate balance sheets”, Chang added.

“Given how much refinancing activity has occurred over the past several years in the high-yield market, it will take more time for maturities and refinancing to become a larger issue.”

Finally, markets will closely scrutinize next Monday’s Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) – after the last quarterly report by the Fed found that banks expected to tighten lending standards over the rest of 2023 – for signs of worsening credit conditions (or worse still for The Fed, improving conditions).

The message – be careful what you wish for: the ‘easier’ financial conditions get, the more likely a new bubble emerges, asset prices re-inflate, and The Fed is forced to stay higher-er for longer-er…