Trader: The Fed Is NOT On The Side Of The Financial Markets

“Be careful in assuming the Fed is on financial markets’ side” Here’s why…

by Kevin Muir of The Macro Tourist

Going to make today’s post short and sweet.

Recently the market has gotten somewhat excited that the Federal Reserve might slow down the rate of Federal Funds tightening. This has been the result of three developments:

  1. A few speeches from FOMC Board members that indicated the Federal Reserve was concerned about the flattening yield curve, and that the Fed’s goal would be to ensure it doesn’t invert.
  2. A recent phenomenon where the effective Fed funds rate is trading at a higher spread to IOER (interest on excess reserves).
  3. The increasing troubles in certain emerging market countries as US dollar liquidity has tightened.

Between these three concerns, the market has built a “dovish hike” into today’s FOMC announcement. Many participants believe the Fed is more likely to slow the pace of tightenings as opposed to increasing it.

Well, sold to them.

I am not claiming to know what the correct policy should be, but I am confident that Jerome Powell’s Federal Reserve will not alter course for any of these three reasons.

The Federal Reserve will hike at least every other meeting until something breaks. Full stop.

Powell will not reduce this pace because the 5-30 spread is hitting new lows. Nor will he care about the effective Fed Funds spread over IOER. And finally, the Federal Reserve has a mandate to set policy for the USA and will not alter course because of emerging market wobbles.

Additionally, there have been stories indicating the Federal Reserve is considering holding press conferences every meeting as opposed to every second one. Although there are plenty of good reasons to change this policy, I believe that Powell is worried he will have to raise rates at a quicker pace in the future.

Let’s face it, on the metrics that matter to the Federal Reserve (employment and inflation), the signals are all pointing to an economy that needs higher rates.

I know true Fed-watchers will tell me that initial claims and CPI are not preferred Federal Reserve indicators, but that’s splitting hairs.

The truth of the matter is that the US economy is doing well. In fact, beneath the hood, it might even be booming.

We are so far away from the Federal Reserve slowing down the rate of hikes. The economy is doing well. Stocks are on their highs. Unemployment is hitting new lows. Inflation is ticking at cycle highs. If anything, I expect the Federal Reserve to increase the pace of tightenings – not the other way round.

I am not sure what this will mean to asset prices, but be careful in assuming the Fed is on financial markets’ side…

Thanks for reading,
Kevin Muir
the MacroTourist