Fed Watch: Bear Market Looms As Central Bank Seeks To Tame Inflation

Inflation expectations in the US are still anchored, but worries are growing that they could become untethered. The concern is that people will give up on the Federal Reserve’s ability to tame inflation and that would push prices higher.

“They’re going to have to watch very carefully,” former Fed chairman Ben Bernanke said last week of monetary policymakers.

“Clearly, they want to see inflation moving downward at a reasonable pace.”

People see gasoline and grocery prices rising every week, and that will affect where they think prices are going. “So, we don’t know how much time the Fed has,” Bernanke says.

The Fed will feel obliged to take more aggressive action if it doesn’t go down because continued inflation challenges their credibility.

St. Louis Fed chief James Bullard, who has been consistently hawkish, thinks the fed funds overnight rate needs to get to 3.5% by the end of the year, which could entail several aggressive rate hikes of a half-point—or more—from the current level of just under 1%.

The current Fed chairman, Jerome Powell, has ruled out a 75-basis-point hike, but Bullard thinks that cannot be off the table. In an interview on Fox News, Bullard commented:

“The more we can front load and the more we can get inflation and inflation expectations under control, the better off we will be. If the Fed can get expectations under control, it can then lower rates again in 2023 and 2024."

While recession fears are growing in financial markets, Bullard still thinks the Fed can engineer a soft landing and avoid a prolonged downturn.

He thinks the economy can “steam ahead,” driven by consumption, but there are numerous indications that consumers are pulling back in the face of relentless price increases.

Walmart (NYSE:WMT) and Target (NYSE:TGT) have taken hits to their profit and their stock prices have plunged, as they reported a buildup of inventories.

Home Depot (NYSE:HD) consumers are more resilient, however. The retailers find the surge in inflation unusual. The picture remains mixed as different income groups react differently.

Last week, Powell continued to be optimistic, however, saying there is “clear and convincing evidence” inflation is coming down. He thinks the labor market will be strong even though some consumers could experience pain from inflation and higher rates.

The Federal Open Market Committee plans to follow through on half-point hikes in June and July, boosting the policy rate to 1.75% and 2%. The Fed will remain flexible, Powell said last week, moving faster or slower on rates as needed.

Financial markets are waiting for the so-called Fed put—action by the Fed to lessen losses for stock market investors. But as Powell insists, the Fed will continue its action on rates until inflation is squashed, that hope is fading.

Stocks are very near a bear market, as the S&P 500 fell 19% by Friday, within a whisker of the 20% decline that defines a bear market. Analysts have lowered their threshold for Fed intervention in the index, which closed at 3,901.36 on Friday, from 3,700 to 3,529, a 26% decline from the closing high in January.

Some analysts are forecasting a decline to 3,000 by October in a prolonged bear market.

The personal consumption expenditures price index, usually referred to as the Fed’s preferred inflation indicator, is due out Friday. The core index for April is expected to fall to 4.9% on the year, from 5.2% in March. A worse-than-expected reading, as one analyst put it laconically, “could trigger a violent sell-off.”