A familiar presence is missing during a time of crisis.

The Federal Reserve has a reputation for stepping in during periods of turmoil. During the pandemic, for example, the Fed cut interest rates to zero and unleashed a wave of monetary stimulus.

The Fed often plays a key role in reversing bear markets and restoring investor confidence.

This time, the stock market rout saw $5.8 trillion in market value evaporate over a four-day period.

That’s a record loss, and the S&P 500 is facing another bear market for the third time in five years.

But the Fed is sitting tight at the moment despite economic growth scares.

That’s because the Fed’s hands are tied.

So today, let’s look at why the Fed’s not coming to rescue the stock market…

Forced to Sit Tight

Congress tasks the Fed with two mandates.

Those mandates are price stability (i.e., low inflation) and a strong labor market.

In recent years, the Fed has made inflation the focus. In 2022, inflation rose to its highest level in 40 years. The Consumer Price Index (CPI) hit 9.0% in mid-2022.

It has come in since then and was most recently reported at 2.4% in March. But that’s still above the Fed’s 2% inflation target.

The Fed’s preferred gauge of inflation is running even hotter – the Personal Consumption Expenditures (PCE) price index. Core PCE strips out food and energy prices that can be volatile from month to month. It’s currently sitting at 2.8%.

Recent comments from the Fed show it’s concerned about the impact of tariffs on the inflation outlook.

In a speech on April 4, Fed Chair Jerome Powell said that “higher tariffs will be working their way through our economy and are likely to raise inflation in coming quarters.”

With inflation concerns increasing again, you shouldn’t expect the Fed to budge much on interest rates.

That sets up a dreaded scenario for the economy… along with more volatility for the stock market.

Growing Risk of Stagflation

The Fed is clearly concerned about inflation. They’re tuned in to the risk that tariffs present to the growth outlook as well.

The minutes from the Fed’s last rate-setting meeting in March highlighted uncertainty around trade policy that could slow consumer spending and business investment.

But at the same time, the inflation outlook is forcing the Fed to keep interest rates at a relatively high level. The Fed funds rate is still at a range of 4.25%-4.50%. That’s near the highest levels of the past 30 years. High interest rates also slow the economy.

That means we could be facing a period of stagflation… marked by high inflation and slowing economic growth.

If you want to track stagflation, you should keep an eye on something called the Misery Index. The calculation is rather simple. You combine the unemployment rate with the inflation rate to track the hardship the average person feels.

Here’s the chart below:

The index spiked in 2022’s bear market and has returned to a relatively low level. But with the Fed’s evolving forecast, I don’t expect it to stay low for long.

Looking back, a rising Misery Index tends to correspond with elevated levels of market volatility. That makes sense because stocks historically don’t like high levels of inflation or economic uncertainty.

The recent burst of volatility is going to stick around.

And with inflation and economic growth both posing problems, the Fed won’t be able to do much to calm things down.

Happy Trading,

Larry Benedict
Editor, Trading With Larry Benedict