If you needed reminding the market remains closely tethered to monetary policy – we received it this week. Stocks surged on the back of two things: (i) CPI coming in slightly better than expectations; and (ii) the prospect of the Fed having more room to ease rates. Bond yields dropped and stocks jumped. There’s nothing quite like the sniff of cheaper money to get the animal spirits moving. However, it’s still far too premature to jump to conclusions.
"Fed Reserve"
A Bad Day for the Fed
A few months ago Jay Powell claimed victory. Last Sept he said words to the effect of “the time has come to start easing rates”. He initially cut rates by 50 points – followed by two more cuts of 25 basis points. Markets were thrilled at the thought of more cheap money – pricing in as many as 6 or 7 rate cuts over the next 12 months. However, at the time I asked why the need to cut? The data simply didn’t support it. Jobs were fine. The economy was growing. Inflation was not yet at its desired level. Why cut? However, whilst the Fed was busy running a victory lap – the bond market was less convinced. The US 10-year yield went the other direction — and appears likely to retest 5.0% in the next few months. What does this do to valuations?
Fed’s Balancing Act for 2025
2025 will not be without its challenges for both investors and central baks. For example, if we consider: monetary and fiscal policy risks; likely introduction of tariffs and price increases; geopolitical risks as global central banks navigate U.S. policy; a stronger US dollar with a rising 10-year treasury yield; ongoing debt and deficits concerns; the risk of stubborn inflation (notably services); and a weakening employment picture – this presents a complex web of related variables or risks. How are markets pricing this in? For now they remain complacent – trading at record highs – at near 22x forward earnings.
End of 20-Year Cheap Money Era
Equities were seemingly caught off balance with the Fed’s ‘surprise hawkish shift’. From mine – there was very little surprising about it – you only needed to look at the data. However, what I was more interested in was how Powell would explain why they were cutting rates. As it turns out he struggled – leading to a small sell off in stocks. The irony was Powell did a better job of explaining why rates should not be lowered (which is obviously at odds with their decision to cut).
For a full list of posts from 2017…