There’s an old adage in financial markets: Don’t fight the Fed.
But the stock and bond markets are doing exactly that. Whether they get away with it is the $64,000 question.
In its policy statement Feb. 1, the Federal Reserve said it “anticipates that ongoing increases in the target range [for the federal funds rate] will be appropriate.” Appropriate to push inflation down to the central bank’s 2% target, that is. The Fed’s favored price index posted inflation of 5% last year.
In his news conference Feb. 1, Fed Chairman Jerome Powell said a “couple” more interest-rate increases are coming. Those would likely be 0.25-percentage-point increases at the Fed’s next two meetings in March and May. And that would leave the federal-funds rate target at 5% to 5.25%.
But many investors and economists are betting that the Fed will stop at 4.75% to 5% -- i.e., one more rate hike from the current range of 4.5% to 4.75%.
And some investors and economists say the central bank will lower rates by year-end in the face of a weak economy.
But Powell said, "given our outlook, I just I don't see us cutting rates this year."
Stocks and Bonds Ignore the Fed
One might think that these and previous statements from the Fed indicating its determination to get inflation under control would be enough to stymie rallies in stocks and bonds. But that hasn’t been the case.
The S&P 500 index has climbed 17% from its October low. And the 10-year Treasury yield has slid to 3.35% from an October high of 4.23%.
This is just the opposite of what the Fed wants. It seeks tighter financial conditions, which means weaker stocks and weaker bonds (higher yields).
To be sure, Powell hinted that the Fed isn’t too bent out of shape by the financial-market gains. "Many things affect financial conditions, not just our policy,” he said. “And we will take into account overall financial conditions along with many other factors as we set policy.”
'A Cacophony of Fed Speeches' on Tap
But the Fed is still concerned, many experts note. “This loosening of financial conditions is undoubtedly not what the Fed was aiming for, and we expect a cacophony of Fed speeches in the coming weeks will aim to reorient the Fed’s message,” Gregory Daco, chief economist at EY Parthenon, told The New York Times.
“In other words, the infernal tango will continue, as the Fed and markets try to find synchronized rhythms once again.”
So where do we go from here? The Fed’s path seems clear, assuming the economic and financial environment remains the same. That path would be two more rate hikes and then a pause.
How stocks and bonds react to that is anyone’s guess. But I’d be wary of getting too bullish about either asset class.
