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The Fed is realizing inflation is a smaller “black hole of pain” than previously thought, Fundstrat said.
The firm pointed to softer comments from Fed officials that suggested a pause in December.
A pivot on rate hikes could lead stocks to rally 16% through the end of this year, Fundstrat said.
The Federal Reserve is starting to realize that inflation is a smaller “black hole of pain” than previously thought, and a pivot or pause on rate hikes could lead stocks to rally more than 16% by the end of the year, according to Fundstrat’s head of research Tom Lee.
In a note on Monday, Lee pointed to recent comments by Fed officials, which dialed back some of the hawkishness that has roiled markets this year and sent the S&P 500 falling 25% since January. Though inflation remains high, the Fed’s Loretta Mester, James Bullard, and Neel Kashkari have made comments suggesting the Fed could pause on rate hikes in December. That led stocks to rally last week despite mixed corporate earnings reports.
“Inflation is becoming less of a blackhole of pain and the Fed sees that,” Lee said. “While skeptics say this is because something is ‘gonna break,’ commentary by Fed members show it is arguably more due to acknowledging that monetary policy takes time.”
Other experts have also noted inflation is trending down, raising concerns that the Fed could overtighten financial conditions if it plows forward with more aggressive rate increases. Wharton professor Jeremy Siegel noted that there is a lag of about 18 months between what Consumer Price Index data shows and what inflation is “on the ground,” meaning the inflation picture could be far less bleak than the Fed initially believed.
“A more nuanced dialogue is taking place regarding CPI as well. [The] Fed conditioned markets to only focus on ‘hard’ data,” Lee said. “Many investors are starting to see the fallacy of looking at lagged CPI versus leading [CPI indicators],” he added.
Labor market conditions are also showing signs of cooling, a key signal the Fed is watching for to understand if inflation is easing.
“All of this, in our view, are reasons that any equity rally should exceed that seen in July, which was the ‘false dawn of a Fed pivot,'” Lee said, noting that the rally in July lasted for 23 days and resulted in stocks gaining 16%. Already, the S&P 500 gained 3% in an impressive turnaround last week, boosted by hope the central bank will ease up on aggressive measures to control inflation.
But other analysts remain skeptical. Ned Davis Research noted that a Fed pause in interest rate hikes wouldn’t be enough to boost stocks, and any gains made would be fleeting until the Fed signals a true policy pivot. And a pivot likely won’t happen until the Fed sees clearer inflation data, more softness in the labor market, or “something breaks in the financial system,” the research firm added, casting some doubt on any potential upside for stocks.
