Chief economist update: The Fed's force is with us

"Suddenly the wheels are in motion. And I, I'm ready to sail any ocean. Suddenly I don't need the answers. Cause I, I'm ready to take all my chances with you." - Olivia Newton-John

Oh yes Virginia, the wheels are surely in motion...suddenly. The Dow and the S&P 500 are now officially in a technical correction - down from their respective 52-week highs by 10.4% and 10.2%, respectively.

Just as I scribbled on this space yesterday, we might be in for a little bit more before the dust settles, the unbelievers fold and bargain hunters go a-shopping. What better way to test "the faith" when dip-buyers are presented with another dip instead of what we've all been accustomed to in the current cycle - a return to record-breaking runs.

Perhaps Wall Street has hit painters - correction territory - that'll clear the way for the resumption of no holds barred buy orders. Sorry to disappoint, but with the VIX index closing at a reading of 33.46 - the highest since August 2015 - there'll be some more volatility and cheaper buy ops to come.

The $64 million question is if this presages a bear market in the making - technically defined as a 20% or more drop in US equities. Has good news (on the economy and in terms of the Fed's efforts to return monetary policy towards normality) turned bad?

For sure, the rise and rise of US bond yields are giving equity investors a run for their money. Though down overnight to 2.82% (Bloomberg data) from 2.84%, the recent rise in the 10-year Treasury bond yields have reduced the S&P 500's premium to 3.05% (including the recent drop) from the 3.7% average in 2017 and a long-term average of 4.4%. Similarly, the sub-2% dividend yield (1.98%) currently being offered by the S&P 500 is now outpaced by what investors could get from buying long-term US Treasuries.

However, these are all based on expectations that the US Federal Reserve will be more aggressive towards lifting interest rates that, in turn, is based that the Fed's prophecy about inflation lifting "this year" will come true.

There's no question that given strengthening momentum in the US economy, full employment and wages on the up and up, that eventually, inflation would lift. The freshly-signed tax cuts ensure this.

But what's wrong with that? The recent correction on Wall Street, if at all, removes the froth and the complacency in the financial markets, aligning it more with America's economic fundamentals.

Surely, as Newton's law of motion - "an object either remains at rest or continues to move at a constant velocity" - posits, the sell orders on Wall Street would continue, "unless acted upon by a force."

Needless to say, that force is the Fed. It might have been Janet Yellen's Fed that, month after month, qualified the "timing and size of future adjustments to the target range for the federal funds rate" based on "a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments" (emphasis on financial and international developments) but it'll be up to Powell's Fed to ensure that "future adjustments"  don't bring the US economy and global economies back to the days of QE dependency, beggar-thy-neighbour polices and other non-conventional policy measures.

If I'm forced to put a finger on it, the Fed's 20-21 March FOMC meeting will mark the turning point for Wall Street.

The Fed could raise the fed funds rate another 25 basis points as expected - signalling to markets that it remains unconcerned over the recent ructions on Wall Street and at the same time lessening upward pressure on inflation. Or it could keep policy on hold until calm is restored on Wall Street - making good on its forward guidance with regards to monitoring "readings on financial ... developments".

"I'm ready to take all my chances with you" Jerome.

Ben Ong is the Director of Economics and Investments at Rainmaker Group. He previously worked as a fund manager, economist, asset allocation strategist, portfolio analyst and stock market analyst. Check out his economics analysis here.

Read more: FedWall StreetDowJanet YellenJerome PowellTreasuryUS Federal ReserveUS TreasuriesVIX
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