: Investors still expect the Fed to lower interest rates in 2023

by | Dec 16, 2022 | Stock Market

Short-term investors have gotten hurt in a repeat pattern while trying to predict the Federal Reserve’s actions. Long-term investors may win their battle. The Federal Open Market Committee raised the federal funds rate by 0.50% on Dec. 14 to a range of 4.25% to 4.50%. The expectation of a slower pace of rate increases following four straight moves of 0.75% had some investors thinking differently: That inflation was easing enough for the federal funds rate to hit its peak for this economic cycle sooner rather than later. Again.

This S&P 500
chart shows a repeat pattern of investors talking themselves into a short-term move, only to reverse after Federal Reserve Chairman Jerome Powell explains the central bank’s still-hawkish policy, based on developments in the economy:


On the right side of the chart you can see the recent pattern related to FOMC announcements. From a 2022 closing low of on Oct. 12, the S&P 500 rose 8% through Nov. 1 (the day before the FOMC raised the federal funds rate by 0.75%). Then it fell 4% through Nov. 3, as shorter-term investors woke up to reality. Then the policy pivot-talk pattern repeated, with the index rising 4% from Nov 3. through Dec. 13, before the FOMC announcement and Powell press conference on Dec. 14 helped set up a two-day decline of 2%. Short-term investors can get burned when Powell doesn’t say precisely what they want him to say. Long-term investors remain convinced that the U.S. economy will head into recession as a result of the Fed’s tightening of monetary policy to fight inflation. This is made clear by the inverse rate curve, with two-year U.S. Treasury notes
yielding 4.27%, while 10-year notes
yield only 3.50%. The 10-year yield is so much lower than the two-year because investors have been buying long. (There is an inverse relationship between bond prices and yields.) A willingness to buy 10-year paper yielding 3.50% shows investors expect the Fed will to reverse course during a relatively near-term recession and reduce interest rates so much that the investors will be sitting on profits. This week’s consumer price index report showed a slower-than-expected pace for inflation, although rents were continuing to increase. “The rental equivalent should soon help the downward trajectory more forcefully as new rental leases have been less expensive, reflecting the slowing economy,” according to LPL Financial Chief Global Strategist Quincy Krosby. Read: Largest mo …

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