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Fed May Need to Talk up More Quantitative Tightening to Regain Control of Markets

ByMichael Kramer
Published 01/13/2023, 03:33 AM
Updated 09/20/2023, 06:34 AM
  • The markets are once again testing the Fed
  • The Fed's forward guidance doesn't seem to be working anymore
  • It may result in the Fed discussing further balance sheet reduction to tighten financial conditions.

    • The recent CPI data has encouraged investors to challenge the Fed's plans to raise the overnight rate above 5%. But the market doesn't seem to care, and rates are dropping across the yield curve following the inline CPI report. The 2-Year Treasury fell to its lowest rate since October and is in danger of dropping significantly.

    If the Fed is determined to raise rates as much as they say and keep financial conditions tight, then the market isn't listening and doesn't seem to care what the Fed wants. 

    This can only make one think that forward guidance from the Fed is no longer working. The Fed may have to dig into its toolbox to convince the market it is serious and potentially talk about increasing the size of the balance sheet runoff or the outright sale of its Treasury and MBS holdings.

    The market knows the Fed is getting to the end of its rate hiking cycle and is fully convinced the Fed will be forced to cut rates in 2023. However, the Fed has consistently noted it planned to get rates to 5% and keep rates high and financial conditions tight for a long time.

    However, despite its best effort and hawkish commentary, the market doesn't care. Financial conditions continue to ease, as the Chicago Fed's Financial Conditions Index has fallen back to a level not seen since May 2022.Chicago Fed Financial Conditions Index

    The market's latest move to go against the Fed was a sharp decline in the 2-Year Treasury, which fell to its lowest rate since the beginning of October. It is the first show of weakness the 2-year rate has shown in months; in what could be a sign, the market is now starting to price in rate cuts beyond the Fed Funds Futures market.

    It will only leave the Fed to talk about its balance sheet as the last option for the Fed to keep rates elevated and the dollar strong enough to keep financial conditions from easing more than the Fed desires.U.S. 2-Year Yield

    The market's latest test is to see how far it can push the Fed to keep financial conditions tight. If the Fed is serious, they will need to push back very hard at some point soon, or they will risk losing control of the narrative and where they want the markets to go.

    Talking about higher overnight rates has lost its effect, leaving the balance sheet as the next option if the Fed wants to regain market control.

    Otherwise, it will indicate that the Fed is OK with financial conditions easing, giving the market the green light to rally more.

    ***

    Disclosure: This report contains independent commentary to be used for informational and educational purposes only. Michael Kramer is a member and investment adviser representative with Mott Capital Management. Mr. Kramer is not affiliated with this company and does not serve on the board of any related company that issued this stock. All opinions and analyses presented by Michael Kramer in this analysis or market report are solely Michael Kramer's views. Readers should not treat any opinion, viewpoint, or prediction expressed by Michael Kramer as a specific solicitation or recommendation to buy or sell a particular security or follow a particular strategy. Michael Kramer's analyses are based upon information and independent research that he considers reliable, but neither Michael Kramer nor Mott Capital Management guarantees its completeness or accuracy, and it should not be relied upon as such. Michael Kramer is not under any obligation to update or correct any information presented in his analyses. Mr. Kramer's statements, guidance, and opinions are subject to change without notice. Past performance is not indicative of future results. Past performance of an index is not an indication or guarantee of future results. It is not possible to invest directly in an index. Exposure to an asset class represented by an index may be available through investable instruments based on that index. Neither Michael Kramer nor Mott Capital Management guarantees any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment commentary presented in this analysis. Strategies or investments discussed may fluctuate in price or value. Investments or strategies mentioned in this analysis may not be suitable for you. This material does not consider your particular investment objectives, financial situation, or needs and is not intended as a recommendation appropriate for you. You must make an independent decision regarding investments or strategies in this analysis. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Before acting on information in this analysis, you should consider whether it is suitable for your circumstances and strongly consider seeking advice from your own financial or investment adviser to determine the suitability of any investment. Michael Kramer and Mott Capital received compensation for this article.

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Latest comments

Mike, you called it. Sadly, many just so not want to believe this type of correction is warranted.
Yes fed cannot come down on rates and it would probably be better if they went to 6 or 7. They cannot pull them down because housing would be right back where it was.
No worries… we are at the top. Down until May.
There has never been a case where the Fed hasn't been behind the curve. History shows they have little real control over recession cycles, try as they may. They're attempting to steer the US Titanic economy with a single paddle.
kramers life peaked when Jpow gave that hawkish Jackson Hole speech that crashed the market in 2022. It's all down hill from there.
Yeah, I like his rationale but boy has he been on a wrong stretch.
how do u figure, he has been bearish?
Yeah, many weeks ago he correctly called a down trend, but it reversed and he did not. While the market has been rising he has continued to predict it dropping.
Time for kramer to go back to incorrectly calling the top for the next 10 years lmao. Week 1....
The fed has lost so much credibility ovber the years that it has become irelavant
lol kramer.
I'm going to re-iterate this as its an important point which can prevent followers from losing money in the future and this can improve the analysis. The FED's objective is not to crash the stock market or "control the markets".   When the fed is tightening, removing liquidity and raising rates it is to slow down the economy, remove cheap money from people and businesses that use that money to expand or buy real estate.   This is done by raising overnight rates and performing QT.   This slows down the economy, reduces services and commodity inflation and that's all they care about.  While stock markets usually go down in that environment, it is not what the FED is trying to do.  Its a result of slowing economy.   So when the market rallies, like it has, despite the hikes, its not the sign of a problem other than traders paying too high a multiple or too high a price for earnings which are not going to be good.    It isnt something that the FED is concerned about.
 Your argument makes sense. However, despite the Fed does not want to control the markets, they are aware that markets should follow the guidance. It is surely interesting, and maybe worrysome, for Fed members, to see with their own eyes that liquidity is so abundant today, that markets have become independent. This realization can be strong for policymakers. It can influence future decisions.
 Liquidity is abundant but not due to a rising stock market.  The liquidity is already out there due to the printing of dollars and over stimulus over two years.  I think it is a risky thing, even presumptuous to dictate what the FED wants when the FED has never communicated it.  No chairman and no FOMC minutes discuss, "we have to get the stock market down".  It is never their objective.  That is where Mr. Kramer misses rallies as he is trying to assert a care-about of the FED which the FED has never stated.   Markets go down because of the FED actions, but the reverse is not true, markets going up does not cause the FED to act.   The FED is acting on wage incraeses and commodity increases.   The FED does not care about how far the market rallies.  Puzzled maybe, but again, no FOMC minutes will discuss the markets are "too high" and need to be crushed to accomplish FED objectives.
I believe your points are mostly correct. However to make the implied claim that the Fed totally ignores the markets when considering how their decisions will affect the economy. when the markets are a vital part of the economy is short sighted.
Excellent analysis
Is Kramer your friend... so cute.
Ya we play tennis every Saturday at the club for several hours then have lunch together. We also do barbecues with our wives at least once a week. In fact, I'm his son's godfather as well. Tomorrow our families will attend Church together at St. Mary's Cathedral. Next week our family will be attending their sons concert. His son Karl plays the timpani. Afterwards we'll probably all head to Frank Pepes pizza in New Haven for a good time. Thanks for asking!
Author has some serious issues with financial markets working normally & smoothly.
Dya really think that ur being dressed in shorts is Powell's major distress ?
Somebody needs to do something to control the markets. They go straight up when earnings are known not to be coming out very good.
The Fed will do whatever it wants, whether we like it or not.
jajaj,  poor guy, don't worry, powel is starting the day with your comments. the level of manipulation of the banks and "speciaists" is unbelievable, but the market doesn't care, we make good money :)
The premise that the analysis is based on is that the FED can only accomplish its goal by tanking the stock market.   Sure, rate hikes usually make a market go lower, but if it doesnt, then the inverse is not true.   The FED is trying to control inflation not the market. Sure, your argument is that if people make money in the market that drives demand, but people can make money in a falling market too.   Stock prices do not affect the price of commodities or services.   Copper price is not going to change based on INTL or TSLA or JPM rising (and falling) in stock price. Eggs will be expensive, even if MSFT is trading at all time highs. This is the part in the analysis which is missed, causing a lot of your calls for further downside to miss the in between market rallies.    I agree, market is not 100% out of the woods yet, given earnings will be somewhat weak, but the preditctions from end of DEC 2022 on mid-Jan market falling did not pan out causing pain for your followers (including me)
You obviously have a serious mental condition that you need to go see a doctor for. The FED don't need to do nothing just because you are losing money. Quit being so emotional and play both sides long and short. If you don't you will always be broke
the neutral one. good one!
The bearish trend will continue until third quarter. Early to go long in this market
You permabears are delusional. Bottom was in October. See you at the top.
Go home bear boy!
The last sentence is the answer to the confusion the author is having.
We all know this is a suckers rally.... by no means have we bottomed. Markets will rally for another week or two before taking its last leg down to create a lower low & thus we will finally see capitulation.
wrong again.. its not the fed. it's the upcoming recession that is being predicted because of the rates..
Totally agregó. But the FED, with his forward guidance of 5% is the same central bank last year spoke about transitory inflation and guided the markets with 1% forward interest rates. Central Banks lacks credibility!!! ECB too.
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