The Fed Has NOT Gone 'Crazy', But...

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by: Lars Christensen

Trump calls the Federal Reserve 'crazy' - he is in fact not all wrong as the decline in global stock markets are a result of tighter global monetary conditions (much more so than because of the 'trade war'.)

On the other hand, the Fed has been right in hiking interest rates this year as inflation risked permanently overshooting the Fed's 2% inflation target.

This is contrary to the stock market sell-off in early 2016 when Janet Yellen's Fed had initiated monetary tightening prematurely. Hikes have been right this year, but it is also very clear that a too aggressive rate hiking cycle (more than three hikes over the coming year) will likely send the US economy into recession.

It is not the Fed's job to support the stock market. The Fed's job is to ensure nominal stability. Sometimes that means (indirectly) supporting the stock market (if inflation expectations are below target), but other times it means going against the stock market if inflation risks are to the upside. At the moment, it is hard to see that the Fed has any other choice than continuing to hike rates and Trump's unfortunate comments make that MORE likely as the Fed will be eager to demonstrate its independence.

Consequently, we do not see the Fed soften its stance in the near term and therefore, we could see the sell-off accelerate further in the coming days. Emerging Markets, as well as Italy, seem to be particularly at risk. This also means that the dollar strengthening could accelerate and the euro weakening is likely to continue.