Source: Wall Street News
When the Fed stops raising rates could depend on three factors: the strike price of the Fed’s put options, the Fed’s psychology, and how quickly corporate credit spreads widen.
When the Fed will capitulate and stop raising interest rates is sparking heated debate on Wall Street.
The S&P 500 has fallen 18% so far this year, approaching a bear market range of 20%. The market has heatedly debated when the Fed will rescue the market, surrendering its hands to the “threat of recession” and announcing that it will suspend interest rate hikes.
Yesterday, Atlanta Fed President Bostic tested the timing of interest rate hikes for the first time, saying that policymakers may suspend interest rate hikes in September after raising interest rates by 50 basis points in each of the next two meetings:
A pause in rate hikes in September may be justified, depending on the economy.
Currently, there are three views on when the Fed will pause rate hikes.
The first, and easiest, is what the strike price of the Fed put option (that is, the point in the S&P 500 when the Fed was forced to bail out). That strike price has now fallen to 3,529 from 3,700 at the start of the year, according to a Bank of America survey of Wall Street investors. Michael Wilson, chief U.S. equity strategist at Morgan Stanley, said the Fed will not come to the rescue until at least the S&P 500 falls below 3,500.
The second is the psychological factor of the Fed. Bank of America economist Ethan Harris said it was understandable that those familiar with the market were unhappy with the S&P 500’s 17% decline since the end of last year.
He contrasted it with “the Fed’s view of the S&P 500,” adding that if there wasn’t an unfounded, chaotic collapse, the Fed would be convinced of the fact that the stock market is still 15% above its pre-crisis peak. . He also noted that since in typical consumption patterns, households respond to persistent changes in prices for about three years, the Fed believes the wealth effect remains positive and therefore can afford more stock market declines.
Harris concludes that, from the Fed’s perspective, a stock market correction sends two messages: It signals investor pessimism about earnings and discount rates, and affects business confidence and consumer spending through the wealth effect.
Looking at these metrics, Bank of America economists have disappointed those longing for a Fed capitulation, as the stock market “hasn’t been outstanding this correction” because “after all, stocks are still well above their pre-financial crisis peaks, S&P The 500 hasn’t even fallen 20% yet.”
Harris said Powell probably thinks we have a long way to go, with a market correction in line with economic weakness, but probably not a recession.
But the third view is much more positive for market bulls. The U.S. corporate bond market is finally sending a welcome, albeit dangerous, signal: The stock market crash is coming to an end, according to U.S. bond research firm CreditSights.
Corporate bond spreads, a measure of the interest rate premium on corporate bonds relative to U.S. Treasuries, have nearly doubled in the past year, according to Credit Sights data, signaling heightened concerns about the performance of U.S. companies.
That credit spread is now starting to narrow, which CreditSights said suggests the stock market is nearing a bottom. The firm looked at seven periods since the S&P 500’s biggest weekly drop in 1998 and found that the average rate of change in credit spreads peaked 42 days before the S&P 500 began to rebound.
Winnie Cisar, head of global strategy at CreditSights, wrote in a note Monday:
The absolute spread between investment-grade and high-yield bonds could continue to widen if historical patterns persist.
But he also noted that the pace of that expansion should slow in the near term, while the pace of change in the stock market could accelerate, bringing the S&P 500 closer to a bottom.
Turbulence in the corporate bond market is starting and growing. Spreads on U.S. investment-grade indexes hit 147 basis points on Monday, according to Bloomberg, close to a level of 150 basis points — the threshold at which many strategists believe the corporate bond market is starting to come under pressure.
The junk bond market has been hit harder as investors lose interest in riskier bonds. The supply of new high-yield bonds is only 24% of what it was last year.
Editor/Corrine
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