The Market Has Overshot On Fed Hawkishness

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Make no mistake: We’re in a nasty bear market and stocks are going much lower. But the market has overshot on Fed hawkishness. As you can see in the tweet above by Jim Bianco, the market is expecting 225 basis points of hikes over the next four meetings. In my opinion, there is no way that is going to happen because the market will crack long before the Fed gets there. I mean it’s already cracking now and they haven’t even done the first 50 point hike!

What does it mean? It means that I’m not overly bearish in the short term. As I wrote last Tuesday, a 50 basis point next Wednesday is now priced in in my estimation. So I wouldn’t expect an overly bearish reaction to next week’s 50 point hike. In fact, it wouldn’t surprise me if we even rallied on the news.

Longer term however: The Fed is trapped. They are trapped between inflation on the one hand and a massive asset bubble on the other. If they are overly hawkish in order to crack down on inflation, they risk a financial meltdown. If they are overly dovish to protect the financial system, they risk inflation spiraling out of control. This is why – as I wrote two weeks ago: There will be no soft landing. Heads you lose, tails I win.

So the Fed is going to have to make tradeoffs. How will they make them? My guess is that they will be reactive. What they should do is tackle inflation – like Volcker did in the 1970s – because it is the greater risk to the long term health of the system. But doing so would result in a collapse of the financial system and I don’t think Powell has the gumption to stick to his guns in the face of that.

Therefore they will go back and forth – alternating between hawkishness and dovishness – depending on whether inflation or the popping of the asset bubble is the more pressing issue of the moment. In the end – by doing so – neither objective will be met. That’s why I expect a long, drawn out and ultimately vicious bear market – but not next week.

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