Shock July rally was a monster the U.S. Fed may regret seeing

While the Fed may be ambivalent about equities in general, the role of markets in mediating a real-world economic lever -- financial conditions -- means they are never completely out of mind.

Believing they heard a dovish tilt from Jerome Powell, traders pushed the S&P 500 up nearly 4 per cent over two days -- and kept on buying Friday. Welcome as it was by bulls, the spike raises the question of when the rebound itself starts to work against the goal of draining bloat from the economy. It’s an issue investors must weigh in calculating the recovery’s staying power.

A dynamic in which surging stocks complicate the goal of subduing inflation is one reason giant rallies are rare in times of tightening. While the Fed may be ambivalent about equities in general, the role of markets in mediating a real-world economic lever -- financial conditions -- means they are never completely out of mind. Right now, those conditions are loosening in proportion to the S&P 500’s gains. Could that be a concern for Powell?

The Fed chief said Wednesday that policy makers will be monitoring whether financial conditions -- a cross-asset measure of market stress -- are “appropriately tight.” But in the days since the central bank’s second straight 75 basis point hike, the measure is now at a level looser than before the first rate hike in March.