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Thursday, January 27, 2022

Fed is walking a 'tightrope' between Wall Street and Main Street

The Federal Reserve, which is poised to begin hiking interest rates as early as its next meeting, is stuck between the proverbial rock and a hard place.

In fact, one could argue that the central bank has at least a few different hard places to avoid crashing into — but two in particular stand out.

In rendering Wednesday’s closely-watched policy decision, the Fed didn’t yield any new surprises, but it strongly hinted at a March rate hike that would be the first of (at least) a few this year.

That was enough for jittery investors to send battered Wall Street benchmarks on a fleeting rally, after a rocky start to 2022 that dragged technology stocks (and briefly, the S&P 500) into correction territory. It was a reminder that the Fed is beholden to a key constituency known as Wall Street, and is now duty bound to keep the markets happy.

“We think the market [has] gotten ahead of itself both from a valuation standpoint and from a speculative standpoint,” Jim Polk, head of equity investments at Homestead Funds, wrote in a note to clients on Wednesday.

“While some stocks are down significantly over the past year ... we think there could be more to come, particularly in the high-flying names. There doesn’t feel like capitulation yet in the market. This is a very dynamic situation with the ‘Fed put,’ which has had investors taking greater and greater risk is being called into question,” he added.

That “put” — i.e. the market’s expectations that the Fed will ride to the rescue with excess liquidity whenever things get hairy — figures prominently in the central bank’s response to spiking inflation.

The Fed is being forced to thread the needle between two competing camps: Wall Street, which has become “quite spoiled” by easy money and clearly doesn’t want the punch bowl snatched away; and a Main Street that’s become hobbled by rising prices, a byproduct of the Fed’s easy money.

Fed Chair Jerome Powell himself suggested that rate hikes were subject to force multipliers like growth and COVID-19, telling reporters in the press conference that monetary policy would have to be “nimble” going forward, as Yahoo Finance's Brian Cheung wrote on Wednesday.

But Powell knocked markets back into a tailspin when he suggested there was “quite a bit of room” to hike rates. That particular remark underscored the delicate balancing act the Fed must maintain as it navigates the hard places of the pandemic, growth, inflation, and a very skittish investor class.