February 1st was a "Fed Day", and the Federal Open Market Committee (FOMC) did almost exactly what they were expected to do. Let's review what happened, and, more importantly, the market response.
Well, there you have it, folks... Kidding, but my God do I love Zero Hedge for gems like this.
As was widely anticipated, the Federal Open Market Committee voted to increase the Fed Funds rate by another 25 basis points. This marks a deceleration in their rate hike path. Up to this point, we've seen four consecutive rate hikes of 75 basis points (3/4 percent) followed by one 50 basis point hike (1/2 a percent) in December.
US stocks, with the S&P 500 and NASDAQ as proxies, seem to have front run this Fed Day. after losing about 20 and 33 percent, respectively, in 2022, the indexes are up 8 and 17 percent on the year.
Dark Blue - SPX, Orange - NASDAQ
Source: Tradingview, NYSE
Both Indexes even got a large boost on the day, following the Fed meeting. Five day view, Dark Blue - SPX, Orange - NASDAQ.
Source: Tradingview, NYSE
Were there any notable insights from the Powell Press Conference? Only one, and I would rate it a quarter percent notable.
Powell's designated corporate press rep, Nick Timiraos at the Wall Street Journal, asked if the committee would consider stopping rate hikes for one or two meetings, waiting for more data to come in, and then determining the course from there.
Powell's answer was, in effect, that the damage the FOMC could do by stopping too early and having the data prove them wrong (i.e. inflation turns hot again) is greater than the damage they could do by not pausing soon enough. Agree or disagree, there is no opacity in his thinking. We aren't dealing with Alan Greenspan.
"If I've made myself clear, you've probably misunderstood me" - Fmr. Fed Chair Alan Greenspan
Another journalist mentioned that Dallas Fed President Lorie Logan had talked about a "pause" to rate hikes in a recent speech, and asked Powell if the committee was considering a move like that. His response was: "That's not something the committee is considering", which is Fed Chair English for: "No, that's ridiculous".
Now, to decide if any of this actually matters. The markets that truly stake their fortunes on what the FOMC will do next are bonds and rate futures. More specifically: Fed Funds Rate Futures.
Analysts have long looked to the Fed Funds Futures market for expectations about where the Fed will take its policy rate. While this market has historically been a terribly imprecise fortune teller, it does have a solid track record of indicating rate cuts quite far in advance. Even the FOMC itself looks at what rate markets are "saying" during almost every meeting.
The market rate on the Fed Funds Futures contract dated December 2023 is what analysts understand to be the market consensus view of what the Fed Funds rate will be in December of 2023.
If that rate is lower than Fed Funds is today, then the market is "pricing in" rate cuts. If it's higher, then the market is "pricing in" rate hikes. Here's a five-minute video that explains how this works more thoroughly.
On this Fed Day, there was no change in the market's expected path for rates over the next year.
Dark Blue - contract rate for June 2023. Orange - contract rate for December 2023
Source: Tradingview, Chicago Board of Trade
In fact, there has been no change in the rate expectations for 2023 since before the Fed's last meeting in December, as indicated by the "flatness" of these contract rates over the last three months. The rate futures market is expecting the Fed to hike to a range of 4.75-5 percent by June (dark blue line). There are 25 to 50 basis points of cuts expected from June to December (orange line). Today's 25 basis point increase did not move either of these contracts out of their trading range.
Where it gets interesting is in the rate expectations for 2024 and onward.
Light blue - contract rate for June 2024. Yellow - contract rate for June 2025.
Source: Tradingview, Chicago Board of Trade
The outlook for Fed Funds over 2024 and 2025 has continued to deteriorate since last November. As of February 1st there are 100 basis points (a full one percent) of cuts expected between December '23 and June '24. To follow, there are another 75 basis points of cuts expected between June '24 and June '25. In total there are 200 basis points of Fed rate cuts priced in over the two years from June 2023 to June 2025.
Historically, the Fed only cuts rates in these situations:
1. Congress needs help paying for a war.
2. The financial system freaks out.
3. Unemployment rises.
While the US stock market seems optimistic in the first month of 2023, the outlook, according to interest rate futures markets, is actually getting worse.
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