But this time, there’s over 8% inflation.
By Wolf Richter for WOLF STREET.
The Dow Jones Industrial Average on Friday closed about 300 points below its June 16 low, thereby having more than wiped out the bear-market rally gains. For the Dow, the bear-market rally started on June 17 and ended on August 16. During the two-month rally, the Dow had jumped 14%. By Friday at the close, it was again down 20% from its all-time high.
The S&P 500 Index, on Friday intraday, fell through its closing low of June 16 – the infamous 3,666 – and then bounced a little to close 27 points above the June 16 low, at 3,693. During the two-month bear-market rally through August 16, the index had surged 17%. By Friday, the index was down 23% from its all-time high.
The Nasdaq closed about 2% above its June low. During the two-month rally, it had soared by 23%. Many of my Imploded Stocks that are now trading for a few bucks, had shot up by 50% or more, and a bunch of them doubled, before re-imploding after mid-August.
The bond market – and with it the mortgage market – experienced a huge bear-market rally, but folks over there came to their senses two weeks earlier, on August 1.
The 10-year Treasury yield had spiked to 3.48% by June 14 (rising yields mean falling bond prices; falling yields mean rising bond prices). By August 1, the 10-year yield had dropped to 2.57%, and that had been a huge rally.
In the mortgage market, there was an even more astonishing bear-market rally: The average 30-year fixed mortgage rate had hit a 14-year high of 6.28% on June 14, according to the daily measure by Mortgage News Daily. The average rate then dropped by 1.23 percentage points to a low of 5.05% by August 1. Realtors were already talking about improving home sales. On Friday, according to this daily measure, the average 30-year fixed mortgage rate hit 6.70%.
The Fed-pivot fantasy did it.
The bear-market rally happened even as the Fed had already embarked on the most aggressive tightening cycle in decades, and had started quantitative tightening, meaning shedding Treasury securities and mortgage-backed securities.
The bear-market rally happened because markets – meaning folks and algos playing in them – had this fabulous reaction to the Fed’s aggressive rate-hike scenario: They began fantasizing about a Fed “pivot” and about rate cuts and some even about QE all over again. Asset prices began to jump and yields began to fall.
Many of us in our illustrious comments on Wolf Street had been expecting a rally. And I drew parallels to the bear-market rally during the dotcom bust. During that rally, which lasted less than two months, from May 27 through July 17, 2000, the Nasdaq jumped by 33% without ever getting back to its old high. Ultimately, the Nasdaq collapsed by 78%.
That bear-market rally in the summer of 2000 suckered a lot of people back into the market, thinking that stocks would be going to the moon again, and they got crushed.
The 2022 bear-market rally started in mid-June and also lasted two months. It came as the Fed-pivot-fantasy mongers – including some well-known hedge-fund managers – had fanned out across the financial media, the social media, and the rest of the internet, asserting that the Fed would soon pivot, that in fact it wasn’t even doing QT after all, and yada-yada-yada.
So we got a huge two-month rally, and the Fed-pivot mongers, including the hedge funds, that got out in time made a huge amount of money. But those people that believed the pivot fantasy and bought when the pivot-mongers sold, well, those folks took the losses. But that’s how it always goes.
The dotcom-bust parallel shapes up.
It was easy to see what they were doing, and it became a hot topic in the Wolf Street comments. On July 19, for example, I said this in a comment:
Out of the last 8 trading days, the S&P 500 finished higher on 2 days (including today) and finished lower on 6 days. We’re due for a summer rally, but so far, it’s been a pretty shitty summer rally.
In the summer of 2000, from May 27 through July 17, the Nasdaq rallied 33%, in the middle of what ultimately was a 78% collapse. Now THAT was a summer rally in a bear market! But it didn’t get anywhere near setting a new high in the summer of 2000. Far from it. The high was 5,000 in March 2000. On July 17, 2000, it got back to 4,275.
The Nasdaq didn’t set a new high until July 2015, 15 years later, and it took trillions of dollars of Fed money-printing to get there. Now the money-printing has stopped, and the Fed is doing QT. And CPI inflation is 9%, and the wage-price spiral has kicked off, and there is a chance that the Nasdaq is going to take a very long time to get back to 16,200.
I’ve been repeating the dotcom-bust parallel because it just keeps getting more parallel, so to speak.
The bear-market rally continued, to the point where on July 31, I warned in a much pooh-poohed podcast that the Markets Are Fighting the Fed, and that fighting the Fed would only cause the Fed to be more aggressive in getting its message across to the markets because it relied on the markets to transmit its monetary policies via the financial conditions to the actual economy and to demand – the markets are its “transmission channel” – and that the Fed would eventually win this fight.
The podcast got 317 comments on Wolf Street. The transcript of the podcast, published on August 3, got another 259 comments. This was a hotly debated topic.
The simple fact is this: a Fed-inflated Everything Bubble.
Since 2008, the Fed has inflated asset prices with interest-rate repression and QE, huge amounts of QE. It caused the greatest asset bubble ever – the Everything Bubble.
QE was designed to make asset holders wealthier so that they then would spend a little more and thereby let some droplets of their newly-gained wealth trickle down. In 2010, then Fed Chair Ben Bernanke, in an editorial in the Washington Post, explained this theory of the “Wealth Effect” to the astonished American people.
The Fed got away with it because it didn’t trigger a lot of consumer price inflation because consumers didn’t get this money; it triggered a huge amount of asset price inflation because asset holders got this money, and with their gains from those assets, they chased after assets with this money, instead of spending it, and so there wasn’t much of a trickle-down.
But in late 2017, with Yellen getting ready to hand over the reins to Powell, who’d been appointed Fed chair by Trump, the Fed started to phase in quantitative tightening. At first, the increments were so small they were hard to see. Then QT picked up momentum.
In early October 2018, markets began to tank. By November, mortgage rates hit 5%, and the housing market started wheezing. By Christmas 2018, the S&P 500 Index was down 20%. Even that small and slowly phased-in QT and little-bitty 25-basis-point rate hikes – just four of them in 2018, to only 2.5% at the top end of the target range – had a big effect on these artificially inflated markets.
But there’s a huge difference between then and now: Inflation.
In 2018, inflation was at or below the Fed’s target, and the Fed was just trying to “normalize” policy, and it was just trying to bring its balance sheet down to a manageable level. It just wanted to get back to some kind of “neutral.” Nevertheless, Powell came under withering pressure from Trump, who’d taken ownership of the Dow. And with inflation below the Fed’s target, and with the Dow in free-fall, and with Trump keelhauling Powell on a daily basis, the Fed did its infamous pivot, and markets soared again.
The lesson was this: These artificially inflated markets cannot even maintain their level amid rate hikes and QT. Even little-bitty rate hikes, just four in a year, and small amounts of QT caused markets to tank, just like interest rate repression and QE had caused them to soar. It was becoming clear to everyone: QT was having the opposite effect of QE.
But in 2022, inflation has spiked above 8%, highest in 40 years, and has spread across the economy and is now spiking in services, away from supply chains and commodities, even as some goods inflation has started to unwind. And there isn’t going to be a Fed-pivot until this inflation is making “compelling” progress, as the Fed calls it, in heading back to 2%, which could be a long way off.
QT until something breaks? Wait a minute…
There have been lots of people who said that the Fed will keep doing QT “until something breaks.” Last time it did QT until the repo market broke. That was when the banks stopped lending to the repo market, which then blew out, which cause the Fed to bail it out in September 2019.
But this time, the biggest thing that the Fed is in charge of has already broken: price stability. Inflation is the worst it has been in 40 years. And the Fed is tightening in order to fix this huge thing that has broken – to bring this inflation back under control and down to 2% (as per core PCE). This could be a long and tough slog. And other things that might break along the way are by comparison just minor inconveniences.
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