The First Fed Meeting Of 2023: What To Expect & 3 Key Questions Going Forward
Financial markets were tense this week as the Federal Reserve had their first meeting of the year that was then followed up by the always crucial BLS jobs report.
In terms of the central bank meeting, these are always an important event for companies, savers, employees and investors everywhere and yet we didn't cover it last week for two reasons:
What the central bankers were going to do was very widely expected.
We have discussed the Fed's expected path slowdown in rate hikes and why it would continue several times before.
You can read about our old recent work here, here and here.
And so it seemed better to wait for the meeting to pass and then discuss what the situation is for the US central bank and the US economy going forward.
Now that it is over we can get to what we think are the three key questions as we look forward.
Let us start with the basics:
What did the US central bankers actually do?
They did two things:
They raised US interest rates by a very slim and "normal" 0.25% increase.
They indicated that they only need a few more increases to reach what they think is the correct rate to bring inflation down and keep it there.
This latter point is super important as it gives investors confidence that they can project and model what to expect in the future going forward. One of the biggest problems with 2022 was the very high unpredictability of what to expect.
As we have pointed out a few times: inflation by itself is somewhat manageable. Unexpected and volatile inflation is deeply problematic.
The latter created a lot of the wild and very unpleasant volatility we experienced.
This unpredictability has changed, which is great. As we argued last week, as inflation begins to come down it becomes less and less a focus for central bankers, companies, investors and eventually, even consumers.
Here is Chair Jay Powell in his press conference on Wednesday:
"We're talking about a couple of more rate hikes to get to that level we think is appropriately restrictive."
The obvious implication is the following:
There isn't a question of the "pace"of interest rate increases anymore. The central bank is back to hiking by 0.25%.
We could see a 0.25% increase in March and May (no meeting in April) and that would be that.
Just like that, the head of the US central bank is saying they could be done increasing US interest rates before Memorial Day.
Or at least that is the expectation.
File under things that seemed unlikely when Chair Powell gave his fire and brimstone speech in Jackson Hole just before Labor Day of last year.
If that is what the US central bank the next obvious question is:
What did financial markets do?
They soared, of course.
Here is the S&P 500 on the afternoon of the Fed Meeting and press conference which starts at 2pm.
Can you see where Jay Powell started to discuss the expected path going forward?
The major US index finished up over 1% on the day but that wasn't all. The next day this strong reaction continued with:
The S&P 500 doing better yet, rising 1.5%.
The Nasdaq composite leaping a shocking 3.3%.
As regular readers will know we have been very positive on US markets and the US economy (and the one doesn't always go with the other!) but we would be the first to state that this has been a far more aggressive reaction than we expected.
To put it in context the S&P 500 is now up ~8% for the year. The tech heavy NASDAQ is up ~15%. Cathie Wood's infamous ARKK fund is up an eye watering 37%+ in a grand total of 24 trading days.
Remarkable.
It is important to state that while we expected a positive start to the year, we certainly didn't expect this.
Markets are always very humbling. That is often stated when people are wrong but, in some respects, it can be even more striking when you are directionally correct but the reaction is so much wilder than you would have expected that you feel stupid nonetheless.
A 20% return for a major US index would be a very strong performance for an entire year and yet it has happened in a month and change. That isn't just notable, it is revealing.
That isn't just important to state for our own credibility (or our bruised ego) but also for what it reveals about where our overall thesis was wrong.
This obviously brings us to the last question which is the all important
WHY has the reaction been so strong?
That is tough to answer confidently. After all, if we had believed it possible we would have made the case!
But at the heart of it, at least in part, seems to be a truism we repeat frequently:
Often a trend can go farther and get far crazier than your (or our) wildest expectations!
You can pick your topic: crypto, meme-stocks, negative interest rates, the shamelessness of Donald J Trump, we are frequently not just surprised but even stunned by just how far a financial mania or a stock bubble or a political demagogue can go.
A second would be that clearly there was a lot of negative sentiment (and short interest) priced into the market that is now being rapidly unwound.
The third part of the answer is something we wish we had focused on more heavily the last 3 months:
Incredibly, US Financial conditions have loosened incredibly since October, far more than we thought possible.e should also state that we think this is wise.
This has done two things very effectively for which we will have to look to the next story.....
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Have questions? Care to find out more? Feel free to reach out at contact@pebble.finance or join our Slack community to meet more like-minded individuals and see what we are talking about today. All are welcome.
