(Bloomberg). A Federal Reserve looking to reduce excesses on the market could be troubled by a rebound in risk assets.

Stocks have bounced sharply since mid-May’s lows and credit spreads have tightened back to levels seen ahead of the March liftoff of interest-rate hikes while the Bloomberg Dollar Spot Index has cooled from two-year highs reached earlier this month. Taken together, a Bloomberg measure of US financial conditions — a cross-asset measure of market health — has returned to levels seen before March’s hike. 

It could be a problem to policy makers. Fed chief Jerome Powell repeatedly stated that financial conditions would shrink if the central bank removed monetary support to counter the highest inflation levels in 40 years. According to Dennis DeBusschere, 22V Research founder, Fed could need to raise the monetary support if price pressures rise and growth continues to be strong, while the markets rally.

“The mechanism through which the Fed is impacting the real economy is through the financial conditions channel,” DeBusschere said on Bloomberg Television. “If the data doesn’t slow, financial conditions will need to tighten more.”

This easing of conditions comes after a week when practically all stocks, from blue-chip to speculative, rose. As traders reduced their rate-hike expectations and fueled a fall in Treasury yields. En route to the biggest rally in 10 years, The halted its longest losing week since 2020. A basket of unprofitable tech stocks ended its seven-week slide. 

For strategists Morgan Stanley (NYSE:), last week’s jump in stocks is a little more than a hiccup amid a broader decline, especially with a Fed eager to cool demand. 

“The more equity prices rise, the more hawkish the Fed will be,” Morgan Stanley’s Michael Wilson wrote in a report Tuesday. “Investors may be underestimating the Fed’s willingness to shock markets if necessary to achieve its inflation goals.”

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