The Federal Reserve of the United States (Fed) delivered its monetary policy decision yesterday. It was a strange decision, to say the least, as the Fed was in a tough spot.
On the one hand, according to the guidance provided by the Chair, Jerome Powell, during the semiannual testimony, inflation was still too high, and further hikes were granted. At the time, bets increased for a 50bp rate hike in March.
On the other hand, the failure of several US banks has alerted the Fed. Overtightening may lead to something breaking in the system – and it did.
So what to do? A pause or no hike would have been negatively received as the market may have interpreted that the banking system’s problems are worse. A 50bp hike would have accelerated the overtightening, thus risking further disruptions in the banking system.
So the Fed opted for something in the middle – a 25bp rate hike.
It was a dovish press conference, despite the staff raising the inflation forecast. Hence, the Fed opted for the safe, dovish statement instead of hiking more as inflation warranted. This is one reason why the stocks may rally even after another rate hike.
FOMC members do not see rate cuts in 2023
But the market does. As it was seen in the past and even at yesterday’s Fed decision, the market can and will the Fed’s hand if necessary.
Rate cuts are bullish stocks. As the chart above shows, the gap between current, future short-term rates signals steep cuts. That’s bullish stocks.
The stock market is resilient
It is easy to be bearish given the recent financial market turmoil, but it would be wiser to “watch the tape”. That is, to check what the stock market did all this time.
Since June, the Fed has hiked the rates by 3.75%. Also, the terminal rate rose. Moreover, the balance sheet shrunk by about 6%. Finally, the 10-year yield rose above 4%.
And yet, stocks gained 10%, as seen by the S&P 500’s performance.
Does anyone still want to be short?
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