{"id":188850,"date":"2023-04-18T11:30:00","date_gmt":"2023-04-18T15:30:00","guid":{"rendered":"https:\/\/ibkrcampus.com\/?p=188850"},"modified":"2023-04-18T12:49:56","modified_gmt":"2023-04-18T16:49:56","slug":"why-are-markets-challenging-the-fed","status":"publish","type":"post","link":"https:\/\/www.interactivebrokers.com\/campus\/traders-insight\/securities\/macro\/why-are-markets-challenging-the-fed\/","title":{"rendered":"Why Are Markets Challenging the Fed?"},"content":{"rendered":"\n

TLDR:<\/strong> Reasonable people disagree about important issues all the time. Eventually, one side is proved right and the other one is, well, sad about being wrong. When it comes to the Fed interest rate path, the stakes are high and either the Fed or investors will be very disappointed (hedge fund managers can get very sad when they lose, sometimes publicly<\/a>.) So why do markets disagree with the Fed?<\/p>\n\n\n\n

There is no disagreement about the near term. The odds of one more quarter-point increase in the federal-funds target at the Fed\u2019s policy meeting on May 2-3 have become a near lock.<\/p>\n\n\n\n

But \u2026 but \u2026 but<\/p>\n\n\n\n

Markets keep pricing in rate reductions in the second half of this year even though Fed\u2019s determination to quash inflation seems almost scary. Their decision to keep hiking came against Fed staff\u2019s forecast of a mild recession later this year.<\/p>\n\n\n\n

Inflation, for its part, hasn\u2019t been cowed by the scary Fed talk. While off from its four-decade peak hit last year, it has stopped improving (or improving fast, at least).<\/p>\n\n\n\n

Consumers also see inflation rising, not falling, in the coming 12 months, no doubt because of the recent leap in energy costs. So they, too, are doubting the Fed\u2019s ability to get it under control.<\/p>\n\n\n\n

And if you\u2019re the Fed, you worry about inflation expectations because they\u2019re at the very heart of any inflation targeting framework. Expectations of high inflation can be self-fulfilling in an economy with constantly adjusting prices.<\/p>\n\n\n\n

Meanwhile \u2026 in another land \u2026<\/p>\n\n\n\n

Short-term interest rate futures are priced for the Fed to cut interest rates by about 150 basis points from September 2023 to September 2024. The swaps market linked to Fed policy dates currently prices in a rate peak of about 5.14% in June, about 55 basis points of cuts by year-end and a combined 190 basis points of cuts by September 2024.<\/p>\n\n\n\n

Why??<\/p>\n\n\n\n

Well, it\u2019s complicated.<\/p>\n\n\n\n

\"SOFR<\/figure>\n\n\n\n

Although the March CPI report was in line with our expectations overall, a key component – so-called “shelter inflation” – which mainly measures rental costs was shown falling from 8.3% to 5.3%.<\/p>\n\n\n\n

Chair Powell\u2019s contention a while back was that inflation was only held high by this somewhat made up measure. And that it would drop like a stone once shelter inflation turned.<\/p>\n\n\n\n

He seems no longer so sure but the market definitely is.<\/p>\n\n\n\n

Furthermore, credit is somewhat tight in the aftermath of the banking turmoil that started with the SVB failure. A fritz in lending can majorly restrain economic activity. Bloomberg consensus now puts the probability of a recession in 2023 at 65%.<\/p>\n\n\n\n

If interest rate markets are wrong (and the Fed is right), the biggest loser is likely to be the equity market: it has chugged along nicely buttressed by the comforting thought of Fed cuts by year end. That kept them from darker thoughts about faltering earnings growth, high valuations and the like.<\/p>\n\n\n\n

S&P 500 companies are expected to report profits declining at the start of the year by the biggest amount since the second quarter of 2020. Stocks also look expensive relative to history. The S&P 500 trades at about 18 times its next 12 months of expected earnings. That ranks in the 81st percentile for valuations going back the past 40 years, according to the wise men at Goldman.<\/p>\n\n\n\n

\"S&P<\/figure>\n\n\n\n

The conclusion? If the cuts currently priced in don\u2019t come, stocks might well tank. And equity investors will definitely be sad.<\/p>\n\n\n\n

What stocks are doing well today?<\/h2>\n\n\n\n

This section is powered by Open AI connected to TOGGLE AI<\/em><\/p>\n\n\n\n

???? Thanks for all your feedback! This section is still paused but an enhanced version is on the way (we promise)! ????<\/p>\n\n\n\n

Aggregated Leading Indicator Update!<\/h2>\n\n\n\n
\"Aggregated<\/figure>\n\n\n\n

Subscribe to Pro here<\/a> to receive our pre-market Leading Indicator newsletter and access all Leading Indicators online! Currently, the Peak<\/strong> and Trough<\/strong> leading indicators are showing statistically significant readings.<\/p>\n\n\n\n