This article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

Thursday, January 27, 2022

Fed is walking a 'tightrope' between Wall Street and Main Street

The Federal Reserve, which is poised to begin hiking interest rates as early as its next meeting, is stuck between the proverbial rock and a hard place.

In fact, one could argue that the central bank has at least a few different hard places to avoid crashing into — but two in particular stand out.

In rendering Wednesday’s closely-watched policy decision, the Fed didn’t yield any new surprises, but it strongly hinted at a March rate hike that would be the first of (at least) a few this year.

That was enough for jittery investors to send battered Wall Street benchmarks on a fleeting rally, after a rocky start to 2022 that dragged technology stocks (and briefly, the S&P 500) into correction territory. It was a reminder that the Fed is beholden to a key constituency known as Wall Street, and is now duty bound to keep the markets happy.

“We think the market [has] gotten ahead of itself both from a valuation standpoint and from a speculative standpoint,” Jim Polk, head of equity investments at Homestead Funds, wrote in a note to clients on Wednesday.

“While some stocks are down significantly over the past year ... we think there could be more to come, particularly in the high-flying names. There doesn’t feel like capitulation yet in the market. This is a very dynamic situation with the ‘Fed put,’ which has had investors taking greater and greater risk is being called into question,” he added.

That “put” — i.e. the market’s expectations that the Fed will ride to the rescue with excess liquidity whenever things get hairy — figures prominently in the central bank’s response to spiking inflation.

The Fed is being forced to thread the needle between two competing camps: Wall Street, which has become “quite spoiled” by easy money and clearly doesn’t want the punch bowl snatched away; and a Main Street that’s become hobbled by rising prices, a byproduct of the Fed’s easy money.

Fed Chair Jerome Powell himself suggested that rate hikes were subject to force multipliers like growth and COVID-19, telling reporters in the press conference that monetary policy would have to be “nimble” going forward, as Yahoo Finance's Brian Cheung wrote on Wednesday.

But Powell knocked markets back into a tailspin when he suggested there was “quite a bit of room” to hike rates. That particular remark underscored the delicate balancing act the Fed must maintain as it navigates the hard places of the pandemic, growth, inflation, and a very skittish investor class.

"Chairman Powell has to walk a tightrope – he needs to communicate that the Fed is 100% committed to bringing inflation back down to 2%, while not causing a recession or stock market crash by tightening monetary policy too quickly," noted Chris Zaccarelli, CIO for Independent Advisor Alliance.

Meanwhile, the pandemic's fallout has made the Fed increasingly accountable to a second critical constituency, and that’s the voting public. Earlier this month, the Morning Brief wrote how soaring prices have joined both the Fed Chair and President Joe Biden at the hip, and with good reason.

Consumers are undoubtedly feeling the pinch of inflation that's outstripping pandemic-era pay hikes. Currently, predictive markets and mainstream polls are predicting a washout for Biden and his party in November’s midterm elections, a response to implacably higher prices.

Evidence of the public’s growing dissatisfaction is showing up everywhere — in polling data, consumer sentiment gauges and general news coverage — all of which reflect how radioactive the issue has become politically as hardships mount.

Yelp customer reviews are reflecting how consumers are mentioning price increases at small business operations that hit a 5-year peak in the fourth quarter, Yahoo Finance’s Alexandra Semenova reported on Wednesday. That data dovetailed with Gallup poll data that found that two-thirds of respondents said the economy is getting worse, Bloomberg reported, and cited high prices as a source of pain.

“We're at full employment [in Arizona] right now ... but prices have gone up for gasoline, ground beef, milk, eggs, nearly everything,” Senator Mark Kelly told Yahoo Finance’s Akiko Fujita last week. “These rising costs are really hurting Arizona families and families across the country.”

Because inflation — the likes of which haven’t been seen in decades — is being felt by just about everyone at all levels, it’s become a very acute political risk.

Price pressures have placed Fed policy squarely at the center of a political hurricane, and will polarize decisions in ways the central bank hasn’t had to contend with in quite some time — regardless of what investors think.

By Javier E. David, editor at Yahoo Finance. Follow him at @Teflongeek

Editor's note: We want your feedback. Please take this quick survey to let us know if we should launch another newsletter. If the answer is yes, what type of content should the newsletter include?

Follow Yahoo Finance on Twitter, Instagram, YouTube, Facebook, Flipboard, and LinkedIn