Not Buying What the Fed is Selling

Updated: Mar 25

The Fed was on autopilot. Its forward guidance made clear that market participants could set their watches to four interest rate hikes in 2018.


That's exactly what happened.

Source: YCharts


The above chart shows the four interest rate increases (yellow) during 2018. The Fed made good on its promise of measured rate hikes.


It didn't matter at the time that President Trump was criticizing the Fed on an almost daily basis.


They’re so tight. I think the Fed has gone crazy.” - President Trump at an October 10th, 2018 campaign rally on the Fed's interest rate policy.


It didn't matter that growth was slowing down.

Source: YCharts


The above chart shows 2018 U.S. GDP quarter over quarter growth. Economic activity decreased throughout the year, which can be consistent with steady rates or even cuts, but the Fed had its path charted.


It didn't matter that inflation was below the Fed's mythical 2% target.


Source: YCharts


The above chart shows the U.S. inflation rate. Again, falling inflation or deflation is often consistent with rate holds or cuts, but seldom interest rate hikes. In hindsight, the Fed had its blinders on.


It didn't matter until it did. The stock market threw a fit.


Source: YCharts


The above chart shows the S&P 500's interest-rate-fueled tantrum in the 4th quarter of 2018. It ended being one of the worst quarters ever for U.S. stocks. Not surprisingly, the Fed quickly pivoted.


The Fed backed off and actually began cutting rates in 2019. It went from autopilot rate hikes to embarking on a new cycle of accommodative policy, seemingly overnight.


You can't make this stuff up.


Given recent history, why is everyone convinced the Fed's "0% rates until 2023" rhetoric is set in stone?


Futures markets are already starting to call the Fed's bluff.

Source: YCharts


Despite the Fed's pledge to keep rates low, the futures market is not buying it. Investors are betting the Fed increases rates much sooner than 2023.


Market participants seem to be anchored to two beliefs...


Higher inflation is a certainty.


The Fed is going to ignore a sustained run-up in bond yields.


I'm reminded of Bob Farrell's #9 Rule of Investing:

When everyone agrees, something else happens.


The about face of 2018 is a clear reminder that the Fed is not a leader, but a follower of financial markets. In our opinion, it wouldn't be wise to anchor to the Fed's forward guidance. Forecasting interest rates, economic growth, and inflation is darn near impossible. Positioning your portfolio based on a neat and tidy Fed forecast could lead to a misstep. Stay nimble and keep an open mind.


The conundrum reminds me of a quote from the movie Naked Gun: From the Files of Police Squad!; Captain Ed Hocken (George Kennedy) is breaking down the survival odds of Officer Nordberg (OJ Simpson):


"Doctors say that Nordberg has a 50 - 50 chance of living, though there's only a 10 percent chance of that."

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