The stock market is wrong: the economy isn’t going to ‘blow a gasket’ just yet, warns economist

While this year’s sharp sell-off in stocks might feel brutal, especially after September’s carnage, the S&P 500 remains in place approx. 17.1% according to Dow Jones Market Data above the level at the end of 2019.

That’s not low enough given the likely size of the Federal Reserve’s action needed to bring rising inflation back to the central bank’s annual target of 2%, according to Steven Blitz, chief US economist at TS Lombard.

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“Yes, markets are being rerouted, but to date they are rebounding from excessive price levels created by Fed policy that has lasted far too long,” Blitz said in a recent note to clients.

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“Financial conditions are tightening as a result, but are not yet sufficient
Concerns warrant the economy is about to blow a seal.”

Blitz pointed out how little financial conditions have tightened compared to previous recessions (see chart) to bolster his case for why the Fed needs to raise interest rates even more than expected.

Financial conditions are tighter, but not enough if you look at past recessions

Bloomberg, TS Lombard

US stocks ended Wednesday in choppy trading lower after rising sharply at the start of October and after the worst September since 2002. William Watts wrote, like the S&P 500’s SPX after a tough September,
-0.20%
usually sees modest gains a month later, but not the Dow Jones Industrial Average, DJIA,
-0.14%
when looking at historical data.

The main problem for Blitz is that this year’s stock market decline was “hardly a market shakeout,” given the roughly 50 percent decline in stocks during the 1974-75 and 2008-09 recessions.

“More specifically, the market got here by pricing in the Fed’s 4.5% solution (4.5% inflation, 4.5% unemployment, 4.5% Fed rate) which everyone believes
will be enough to exert maximum downward pressure on inflation,” said Blitz. “It won’t.”

Investors have been focused on Friday’s September jobs report for clues as to whether the Fed could maintain its pace with outsized rate hikes amid robust wage growth that has fueled inflation.

Related: Hiring and job creation fall to 1 1/2 year low in September US payrolls report

Instead, Blitz estimates that the Fed’s “fix” may need to hit 5.5%, especially as household balance sheets have remained resilient so far, even as interest rates have risen dramatically, cooling the housing market as the 30-year slowed Fixed mortgage rate approaching 7%.

Energy costs as a component of inflation came back into focus on Wednesday as crude oil prices rose after major oil producers agreed to cut their collective crude oil production by 2 million barrels a day from next month.

The decision was followed by US benchmark crude West Texas Intermediate for November delivery CLX22,
+1.75%

CL00,
+1.75%
rose 1.4% to $87.76 a barrel.

US crude prices have fallen from an intraday high in March of nearly $130 a barrel, according to FactSet data, after surging as the global economy first emerged from pandemic lockdowns but also as the switch to greener ones Energy sources gained momentum and Russia’s war in Ukraine.

Read: Why housing has ‘plenty of room to maneuver’ in a recession, even if prices fall 15%

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