Powell and Wall Street's Strategist Divergence

Yesterday, Fed Chairman Jay Powell calm bedside manner so soothed the stock market that he ignited a powerful rally. The Fed announced it would dial back its bond buying program and pencilled in three 25 basis point rate hikes for 2022 and another two in 2022 that would put the Fed Funds rate at .9% in December 2022 and 1.5% in December 2023. The market had already priced in the rate hikes and with the Fed forecasting the core PCE increasing 2.7% next year, a negative real funds rate of 1.8% can hardly be consideried restrictive. In fact the policy plan will remain highly stimulative throughout 2022.

To me the fly in the ointment is that the Fed's estimate of core inflation is way too low. Powell hinted at that when for the first time he mentioned the rise in paid rent and owner's equivlaent rent. As I have noted many times, I believe that the rent component of the price indices will be up 6% year-over-year by next December. That and rising wage costs will bake in price increases above 4% for the Core CPI and close to that for the Core PCE. Thus the rate environment will be far more challenging as 2022 unfolds.

This where Wall Street's strategist divergence comes in. The range of strategist forecasts for the 2022 yearend S&P 500 ranges from 5200 -4400, compared to a current level of of around 4700. Credit Suisse is at 5200,while Morgan Stanley is at 4400 with Gooldman Sachs. BofA, and Citi falling in between. My guess is that all of them will turn out to be correct with the market at some points during the year will trade at both high end and the low end of the range.

As readers of this blog know I have been bullish on a Fed fueled stock market since January 2020. (See Shulmaven: A “Rational” Basis for Supporting Today’s Stock Market Valuation and Shulmaven: The Fed Green Lights the Stock Market) Because I am more bearish on inflation and interest rates, I can no longer be as bullish as before. The way I see 2022 playing out is that the highs for the year will be hit early on and lows will be plumbed towards the end of the year as the market begins to price in a tighter Fed. Further my view would be consistent with the history of midterm election years being difficult ones for the stock market.