The Fed Needs To Regain Control Of The Market Before It’s Too Late

Rates are down, the dollar is weakening, the VIX is plunging, commodities prices are surging, and the stock market is working hard to stay afloat. This is probably not a good sign for stocks once financial conditions begin to tighten again, which at some point they should, as long as the Fed wants them to.

The Fed may have an opportunity to push this week when Vice-Chair Lael Brainard speaks on January 19. She is one of the more dovish Fed members. This would make her pushing back against the recent easing of financial conditions all the more meaningful.

It could be a huge blow to the bulls. Despite the recent easing of financial conditions, stocks have struggled. Since November 3, 2022, the dollar has weakened dramatically, nearly 10%, a massive move in a short time for a currency. Over that same time, the 10-year rate has fallen more than 70 bps, while the VIX has dropped from 24.6 to 18.3. Meanwhile, the S&P 500 is up a mere 6% over that time and appears to be range bound.

Financial Conditions Ease

On top of that, there was a massive easing of financial conditions, with the Chicago Fed Adjusted National Financial Conditions index dropping sharply. On November 4, financial conditions were near neutral; today, they are at a point that could be called accommodative. The last time the adjusted national financial conditions index was at this point was back in March, and the S&P 500 was trading around 4,200.

So while the S&P 500 can rally further should financial conditions ease more, the S&P 500 index hasn’t rallied very far yet. This is important because if the Fed is in the mindset of trying to keep financial conditions tight and begins to push back against the market, then financial conditions will just start to tighten again, sending stocks lower.

A Fed Pushback

If the Fed has given up its battle against inflation, and to this point, that doesn’t seem to be the case, and the Fed allows financial conditions to ease further, then stocks could run higher. But to this point, the Fed has not signaled that, and in the FOMC minutes, they talked about the unwarranted easing of financial conditions. The odds that the Fed will likely have a significant policy shift between now and the next Fed meeting in February are probably low, meaning financial conditions should begin to tighten. Even following this week’s inline CPI report, Fed officials continue to talk about raising rates and targeting a 5% overnight rate.

A good tell will be this week when Lael Brainard speaks on January 19. She has been on the more dovish side of things in the past, and commentary from her that sticks to the script of warning markets against the unwarranted easing of financial conditions would certainly not be welcomed the news and likely trigger the next round financial conditions tightening.

Despite all of the excitement because of the S&P 500’s two-week win streak to start 2023, it is essential to remember that this is a market that has seemingly gone nowhere over the past month despite a massive amount of financial conditions easing, which one could argue should have led to a much bigger rally than what has been witnessed.

The bears may have much more control over this market than the bulls think.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.