Stocks lost ground again on Monday following a turbulent week that saw market volatility at its bumpiest level since July.
These mercurial markets come as investors overreact to data in eager anticipation of the Federal Reserve's next interest rate policy decision, said Alan Blinder, former Fed Vice Chair and Princeton University economist.
Expect the swings to continue until the Fed declares "mission accomplished" in its fight to lower inflation and pivots away from its current regime, likely some time in 2023, he told me.
What's happening: Markets and the Federal Reserve have conflicting temperaments, said Blinder. Markets are capricious while the Fed remains calm. Markets and the central bank generally have the same interpretation of incoming data — a hot employment or inflation report means more tightening is ahead — but markets greatly exaggerate the data's magnitude, he said.
Markets on average, said Blinder, overreact to inflation-related data by a factor of three to 10 times more than they should. "That's what's going on now," he said.
Federal Reserve Chair Jerome Powell knows this, he said, and has been "very aggressive" in his attempts to signal that a pivot away from interest rate hikes won't happen anytime soon. But that doesn't mean investors will listen.
"I hope it's not another year," until markets become less volatile, said Blinder, "but it might be." Expect the whiplash to continue as long as "the Fed is raising interest rates or believed by the markets to be on the verge of raising interest rates."
We've only just begun: Investor memory is very short, said Blinder. It was only a year and a half ago that policymakers were worried about inflation being too low.
"Inflation is young," he said, and we're a long way from inflation expectations becoming deeply entrenched into economic activity the way it was in the 1970s and 1980s. So while Wall Street may be shouting fire, there's no reason yet for Main Street to worry about the economic meltdowns seen the last time inflation was this elevated.
Last week's unemployment number may have been too low for investors' liking, he said, but it's important to remember how much growth has slowed since the Fed began tightening earlier this year. The US economy added 263,000 jobs in September, but that's a lot lower than the 431,000 jobs added in March 2022.
Sticking the landing: It would be a real stretch to say we're currently in a recession, said Blinder, but the chances of a recession in 2023 are better than 50%. For now, he expects the Federal Reserve to raise rates again by three-quarters of a percentage point in November.
Read more: Blinder's latest book, A Monetary and Fiscal History of the United States 1961-2021, is out today.
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