The stock market is wrong: the economy will not yet “explode a joint”, warns an economist

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

That’s not low enough, given the likely scale of Federal Reserve actions needed to bring soaring inflation back to the central bank’s 2% annual target, according to Chief Economist Steven Blitz. American at TS Lombard.

“Yes, the markets are routed, but, as of today, they are resetting from too high price levels created by Fed policies that have gone on for too long,” Blitz said in a recent client note.

“Financial conditions are tightening accordingly but are not yet sufficient to
substantiate concerns that the economy is about to blow a joint.

Blitz pointed to how little financial conditions have tightened (see chart) compared to past recessions, to bolster his case for why the Fed still needs to raise its key rate more than expected.

Financial conditions are tighter, but not tight enough compared to past recessions

Bloomberg, TS Lombard

US stocks ended lower on Wednesday in choppy trading, after rebounding strongly to kick off October and after their worst September since 2002. William Watts wrote how, after a tough September, the S&P 500’s SPX,
-0.20%
generally sees modest gains a month later, but not the Dow Jones Industrial Average, DJIA,
-0.14%
when reviewing historical data.

The main problem, for Blitz, is that the decline in stock markets this year was not “an upheaval” when one considers the roughly 50% drop in stocks during the 1974-75 recession and the from 2008-09.

“Specifically, the market got here valuing the Fed’s 4.5% solution (4.5% inflation, 4.5% unemployment, 4.5% funding rate) and everybody there believes.
enough to exert maximum downward pressure on inflation,” Blitz said. “This will not be the case.”

Investors focused on Friday’s jobs report for September on whether the Fed could maintain its pace of outsized rate hikes in the face of robust wage gains that fueled inflation.

Related: Hiring and job creation set to fall to 1.5-year low in September US jobs report

Instead, Blitz believes the Fed’s ‘fix’ may need to reach 5.5%, especially with household balance sheets remaining resilient so far, even as interest rates have risen significantly, this which has cooled the housing market as the 30-year fixed mortgage rate approaches 7%.

Energy costs as a component of inflation returned to the center of attention on Wednesday as crude prices rose after major oil producers agreed to cut their collective crude production levels by 2 million barrels per day, starting next month.

The move was followed by US benchmark crude West Texas Intermediate for November delivery CLX22,
+0.21%

CL00,
+0.21%
gaining 1.4% to $87.76 a barrel.

U.S. crude prices fell from an intraday high in March of nearly $130 a barrel, FactSet data showed, after surging as global economies emerged from pandemic shutdowns for the first time, but also as the shift to greener energy sources was gaining momentum and Russia’s war in Ukraine.

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