Fed Rate Update

The Fed decided on increasing 75 BP yesterday. Then something strange happened. Markets rallied hard. Here's why.

Market Rally Explanation

As the fed has been increasing rates in its fight against inflation, markets have been getting absolutely depressed. 

That's because as interest rates rise, liquidity dries up as money gets more expensive.

For example, taking out a mortgage at 6% gets a lot more expensive than it was at 3%.

This is an example of liquidity getting drained out of the system.

Stocks and crypto in particular, which have flourished on cheap money, get punished severely as interest rates go up.

When the Fed announced another 0.75% rate hike yesterday, something strange happened.

Fed Meeting Decision

During Fed Chair Jerome Powell's 1-hour long press conference, bitcoin shot up 10% and the Nasdaq jumped 4%.

Powell said “we are now at levels broadly in line with our estimates of neutral interest rates”. To put this in in plain terms we are driving on a road and on the left is rampant inflation and the right is recession.

Powell said they have data now from previous rate hikes now and they are making better informed decisions on rate increases. This is bullish news for the markets because the biggest enemy of investing is uncertainty.  

Neutral is the key word here. 

There's no exact definition, but it's the Fed saying they've been forced to play catch up with inflation so far. Any additional rate hikes going forward would be actively restrictive.

Powell went on to say “From here onwards, we are fully data dependent”. In other words, they've previously made clear that they will hike rates come hell or high water, no matter what breaks.

Bond markets respond to rate hikes as well. If bond yields go up, markets are expecting more tightening. If yields go down, they're expecting a more dovish Fed.

Conclusion

And here's what the market expects:

- 0.50% hike in September
- 0.25% hike in November
- 0.25% hike in December
- 0.50% rate cut for 2023

Forward looking view is that rate hikes will get lower and lower, and even reverse next year. Current expectation is that the Fed's most hawkish posturing is behind us.

The hope is we don’t see any more increases but the current money supply is obviously still a huge problem.

stay tuned with the Newsletter if you’re interested in getting my bi-monthly fed interest rate breakdown.