Federal Reserve Chairman Jerome Powell testified during a House of Representatives Financial Services Committee hearing on Pandemic Response oversight of the Treasury Department and the Federal Reserve at the Rayburn Building on Wednesday, December 1, 2021.
Tom Williams CQ-Roll Call, Inc. | Getty Images
If you want to see how difficult it is to be Federal Reserve Chairman Jerome Powell, check out the contrasting comments from Cleveland Fed President Loretta Mester and former Dallas Federal Reserve President Richard Fisher.
Asked on our air today what the central bank should do in response to the crisis in Ukraine, Fisher said: “I would not respond to what is happening in Ukraine, mainly because we do not know how long it will last.”
At the same time, Mester spoke at a conference at her organization, where she said that the crisis in Ukraine “has consequences for the economic outlook, adding increased risk to inflation, even when it risks lowering the growth forecast.”
These contrasting comments underscore Powell’s dilemma.
Both mandates: Which one gets the advantage?
The Fed has two mandates: it must help the economy grow and it must fight inflation.
Matt Mali of Miller Tabak notes that “the crisis in Ukraine has the potential to slow growth, so the Fed probably has to go slow in raising interest rates. But the crisis is also fueling inflation, so the Fed can’t ignore that.”
Who has the advantage? How does Powell cut this needle?
Mailey believes that Powell will take the “middle way”: he acknowledges fears of growth, but will continue the course to raise interest rates.
“We have a situation where Powell and the Fed have mistaken that inflation is transient, so they have to raise interest rates, otherwise they will lose confidence.
However, “the market now believes that the Fed will not be as aggressive as they were even a month ago.” Mali believes an increase of 50 basis points in March is unlikely. He says the central bank will make 25 basis points in March, but they will leave at least four more table increases for the year.
Mali is particularly concerned about signals from the bond market and what it suggests for potentially lower growth.
“Yields are much lower than they were last Thursday when the war broke out, but the stock market is no lower. Someone is wrong, either the bond market or the stock market. growth. “
The problem for stocks: Lower growth means lower profits
Shares are driven by a combination of three factors: dividend growth, profit growth and market ratio (price-earnings ratio), which is a reflection of how much investors are willing to spend on future earnings.
Almost all of the stock’s decline this year is due to multiple compression: the S&P 500 is down nearly 10 percent, while the market multiplier has also fallen about 10 percent, from about 21.1 to about 19.1.
At the same time, the distribution of dividends has slightly increased, while earnings expectations remain roughly the same.
Analysts expect earnings growth of 7.8% for the S&P 500 in 2022, just below expectations of 8.4% at the beginning of the year, according to Refinitiv.
Others express the same concern as Mali: that the crisis in Ukraine and its subsequent inflation will take a second step down stocks.
Nick Reich of The Earnings Scout notes that this second step down may not be due to a downturn in the market, but to a real downturn in earnings forecasts because rising Fed interest rates will slow the economy.
“We don’t know how long the Fed will need to raise interest rates to curb inflation,” Reich told customers. “While some companies forecast eight interest rate hikes this year, our study shows that four hikes will stop inflation. This is good news. The bad news is that it will probably come at the expense of future growth. “
“In the next few months, there is likely to be a fear of growth,” he said.
You may even start hearing the “R word” [recession]which shares are not discounted. “Reich noted that if estimates in the second half remain stable in the coming months,” we could become less bearish or even bullish. “
Furthermore, we also do not know how long the war in Ukraine will last and what economic sanctions they will have on the economy.
“The question is, how does the Federal Reserve create a soft landing?” Mali asked me. “It’s not clear if they can.”