February 3, 2023 10:50 a.m. | 2 minute read
Stocks continue to rally since the Federal Reserve hinted that the aggressive streak of rate hikes was coming to an end. At first glance, markets appeared undecided after the statement was released, but viewed the press conference as dovish. Beyond anything a bit more hawkish, like the need for more substantial evidence that monetary policy is tight enough, Powell’s acknowledgment that the disinflationary process has begun was an obvious part of his comment that bulls are skeptical of. are firmly attached.
Despite another 25 basis point hike expected at the March FOMC meeting, investors acted as if the Fed was ready and willing to turn to monetary easing sooner rather than later. The S&P 500 is up nearly 20% from October lows, but the 10-year Treasury yield is down nearly 20% and the US dollar index is down more than 10% , suggesting that the economy and corporate profitability may continue to erode. Market participants also believe that inflation will decline faster than the Fed currently thinks. Futures markets are pricing in rate cuts of around 50 basis points by the end of 2023, while the Fed’s target remains at 5.1%.
Excluding the stock market, bond markets are not as bullish on the economy. As the fed funds rate rises, the two-year Treasury yield continues to fall. This implies that the Fed is close to the so-called “pause” and potentially risks overshooting rates on the upside. Another warning is the spread between 3-month and 10-year rates, which has not experienced this level of inversion since before the 1982 recession triggered by a restrictive monetary policy to fight against rising inflation.
The Fed worried about the risk of a reacceleration of inflation, which is justified given the distance of inflation from the objective. Powell continued to stress the need for further rate hikes to get inflation firmly under control and said policymakers would not become “complacent” despite encouraging recent data. In conjunction with the policy-sensitive fall in the two-year yield, the Fed is making it clear to the markets that it is prepared to overvalue to ensure that it beats inflation.
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