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Fed shouldn't get baited by vigilante stock traders

Jonathan Levin
Jonathan Levin8/18/2022 02:13 PM GMT+08  • 6 min read
Fed shouldn't get baited by vigilante stock traders
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Federal Reserve policy makers don’t have an explicit target for US stocks or consumer borrowing costs, but they know something’s off when they see it, and there’s a chance that now is one of those times. The S&P 500 Index has rallied 17% from its June lows through Tuesday, and consumer credit is growing at one of the fastest paces ever — developments that seem antithetical to the Fed’s goal of curbing the worst inflation in 40 years.

The thing is, the problem isn’t uniform, and the Fed should avoid upsetting the whole apple cart. Instead of throwing out his interest rate road map, Fed Chair Jerome Powell is likely to try some deft jawboning when he speaks later this month in Jackson Hole. He just needs to convince markets that policy makers are committed to their fed funds projections and that they have no plans to cut rates in 2023.

The Fed, of course, fights inflation by raising interest rates and “tightening financial conditions,” which implies some combination of a stronger dollar, higher borrowing costs and shrinking stock portfolios. The Fed can push the short rate around all it wants, but its policy wouldn’t be terribly effective if financial markets didn’t react in turn. The policies work in part by making it harder to finance homes and automobiles and making people who own financial assets feel a little bit poorer and less inclined to splurge on consumer goods. Many indexes track the broad concept of “financial conditions,” including one from Bloomberg that includes such factors as money market spreads, bond market spreads, the S&P 500 and the Chicago Board Options Exchange Volatility Index. If you follow these indexes, it has looked recently as if conditions are loosening back up again.

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