Danger of rapid Fed hikes raises market’s deepest pain alert

Nervous markets fold as Powell signals they must go it alone

While equity markets are “nowhere near the strike price for a Fed put,” the central bank’s plans could be stymied if incoming information suggests underlying economic momentum isn’t as strong as it currently appears, said Evercore ISI strategist Krishna Guha, a former official at the Federal Reserve Bank of New York.

The Federal Reserve’s planned rate-climb way could be vexed assuming that financial conditions fix excessively fast, as indicated by a previous authority of the U.S. central bank. Fed Chair Jerome Powell embraced a rate takeoff in March and made the way for more successive and possibly bigger climbs than anticipated to cool inflation. That could make stocks specifically sink, and prompt policy creators to step in to release strategy, in what’s frequently alluded to as the “Fed put.”

“We will ponder whether we should move our base case from four hikes plus quantitative tightening this year to five +QT” given Powell’s comments, Guha wrote in a note Wednesday. “The huge caveat is whether anything along these lines could be delivered without a blow-up in financial conditions that short-circuits the process.”

Markets are adjusting after Powell said policy must be “nimble” to confront risks including inflation, with the 10-year Treasury yield jumping nearly 10 basis points on Wednesday and the Cboe Volatility Index or VIX closing at 31.96, its highest level in a year. That comes as the Bloomberg U.S. Financial Conditions Index dropped on Monday to its lowest level since November 2020 — though it remained in positive territory, indicating accommodative conditions.

Even if macro data support a faster return to a more normal policy setting and Fed action at consecutive meetings, the pace of such transition could “detonate” a significant tightening in financial conditions across credit and equity, Guha noted. That could result in “the Fed seeing enough of a downside risk to growth to slow down again,” he wrote.

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