The Biggest Implication of the Market Stress

In the past few days, I’ve focused on the fact that corrections like this are totally normal and entirely fit within the financial plans that we create and that we can expect more volatility in the short run but have no new expectations about returns.

Today I want to focus on what is probably the most impactful implication of the current stock market rout, which is, in my opinion, the Federal Reserve is now on hold until next year.

I’ve written many, many articles about when the Fed would stop their bond buying program and when actual interest rate liftoff might actually occur.  Just last Thursday, I sided with former Fed governor and Macroeconomics chair Larry Myers, who said openly to the Fed, ‘what are you worrying about, September or December?  It doesn’t matter, just pull the trigger.’

Well, that was then and this is now.  Not even a week later, I don’t think the Fed can raise rates in September or December and am personally willing to make one-dollar wagers (up to five dollars) that the Fed doesn’t raise rates until next year.

They have said all along that they will be ‘data dependent.’  Of course, they were talking about data like the unemployment rate, gross domestic product (GDP) and inflation.  But, I don’t think they can ignore the market data, which is clearly signaling that economic risks are elevated from just a week ago.

As one of my favorite economists, Alan Blinder, said to the Wall Street Journal, ‘If markets are anything close to the sort of tizzy that they have been in the last few days, then the Fed will not throw a match into the fire.’

Although blue chip economists thought that the Fed would hike in September, markets were betting on December.  In the past few days, those bets have moved into next year.

Of course, the Fed could still surprise markets.  As recently as Monday afternoon (after the big down day), Atlanta President said that he thought a hike was still in order this year.  While that was softer than his previous comments about a September hike, his comments didn’t leave much room for a different interpretation.

Staff economists are no doubt busy preparing simulations that show how a weaker than previously estimated Chinese economy would affect the US.  I’ve seen estimates that suggest that if Chinese growth fell to three percent (a hard landing from their current stated seven percent growth rate), that it would shave a percentage point off of our GDP.

That’s probably too negative an assumption, but the point is that a drop like that would require some kind of monetary stimulus – exactly the opposite of a hike.  Since we can’t cut rates, it would mean another round of quantitative easing, or bond-buying program.

We’ll know more about their thinking later this week as central bankers from all over the world converge on Jackson Hole, Wyoming for the Kansas City Fed’s annual symposium.  The agenda, ‘Inflation Dynamics and Monetary Policy,’ looks pretty dry, but their timing couldn’t be better.