By Gary Anderson,

here is a warning from Tim Duy that the Fed views inflation as being in the danger zone. This does not mean the Fed is right. It does not mean the Fed is wrong. But it means the Fed will likely take down the stock market.

The capitalist fear of workers making too much money is now coupled with the Fed’s understanding that bonds are collateral, in such massive amounts that they simply cannot tolerate large jumps in long interest rates.

By hitting the short rates hard, the Fed will give confidence to those in the bond market that long bonds are still worth buying. If there is an inversion, oh well.

This is what came from the Fed itself, even though it is not reaching its 2% inflation target:


In gauging the appropriate path for monetary policy over the next few years, the FOMC will continue to strike a balance between avoiding an overheated economy and bringing PCE price inflation to 2 percent on a sustained basis.

It is pretty clear that 2 percent is a ceiling, not a target. Overheating is new language for the Fed. Stock market investors most likely should take those words seriously. The Fed is heating up to the threat of overheating.

As Tim Duy says, the Fed, through Lael Brainard, views headwinds to a heated economy as now becoming tailwinds.

Professor Duy warns of an increase from three hikes to more hikes and responded to Brainard’s words this way:

Yeah, that’s not a coincidence. That’s kind of hitting us over the heads to prepare ourselves for changes in the forecasts and the statement with the next FOMC meeting. First thought is that we will see the “overheating” language appear in the statement, which is to be interpreted as a warning that while they intended to maintain gradual rate hikes, it is more likely that incoming data will trigger an increase rather than decrease the pace of hikes.

Duy says fundamental changes are coming. Hikes will be fast or blunt body blows. Or both. Duy is saying the gradualism is over. 

Preservation of the New Normal may not be the preference of the Fed, but the bonds as collateral is a new reality. There is little wiggle room when margin calls are the issue. The financial institutions are more important to the Fed than workers making a little more money. So gradually, over time, they make a little less and then a little less money.

The question remains, how long can society go with workers’ wages being pinched. I had said in the past that women coming into the workforce has delayed the potential side effects. And then credit has been eased. And now there is an increase in multigenerational living.

But at some point, will we be left with child labor? Surely the Fed knows the ramifications of calling our bumbling economy an overheated one. But bond hoarding has tied its hands. And words revealing the true Fed intent are made known with the help of Tim Duy.

We have Alan Greenspan saying the bond bubble is unwinding. Does he really want the bond market to unwind? This is the man who presided over the beginning of bond hoarding for structured finance and pointed out the long end conundrum over a decade ago. He is hardly trustworthy when it comes to speaking to higher rates and bond bubbles unwinding. It is for investors that he speaks this way, in my opinion, because he once said investors think that bond yields are two low.

But, he likely wants bond yields to bump up so that weak hands will leave and insider investors can flood into bonds and out of stocks, because once a Fed person, always a Fed person. And the Fed is signalling the same thing, that bonds are to be protected and stocks are vulnerable.

Stocks are the one asset the Fed will take down without reservation. History shows this to be absolute truth in the arena of economics. Caution is called for.

Note: This article first appeared on our partner site TalkMarkets

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