There’s no Fed Put

Disclaimer: this is not investment advice. Before taking any investment decision, do your own research.

Each FOMC meeting we go through the same cycle:

• Markets participants start speculating on a “pivot” or slow down in rate hikes.
• The Fed hikes rates while insisting on “staying the course.”
• Markets drop.

What I see behind this behavior is recency bias. Markets participants are stuck in the low inflation, Fed inflated assets period of 2001–2021. It’s two decades that made most markets participants accustomed to having the Fed fueling assets as normal. Which made quite a few of them think that the Fed tries to keep markets from collapsing, that is, a “Fed Put.”

But the Fed never intended to have assets prices increasing. It’s dual mandate is low (core) inflation and low unemployment. They don’t care about bubbling or crashing markets. They never did. The only reason to pay attention to assets prices is in how they affect inflation and employment.

So I don’t expect the Fed turning around for many months, probably years.

And I don’t expect the Fed to lower the pace of rate hikes unless there’s clear signals that inflation is going down.

Forecasting rate hikes

My take is that the Fed needs to get to positive real annual rates before March 2023 and keep them positive. Having positive rates removes some of the feedbacks in inflation expectations and avoids spirals. Base on recent CPI numbers, positive real rates would require 6% now and probably a little lower in coming months. I expect one or two 75 bp rate hikes and then moving down to 50 bp for a few meetings. Longer term I expect the Fed to keep real rates in a +/- 2% range. So if, for example, the first quarter core inflation is 4% annualized, I wouldn’t expect the Fed lowering rates unless they are over 6%.

Forecasting markets

Nobody knows what markets will do. But I’ll bet a little that the lesson on Fed not caring assets prices going lower is not learned yet and next FOMC meeting we’ll keep reading about a pivot. And so, the bear market will continue.

Note: this was written in october 2022 but not published. Since it’s mostly still relevant, I published without the missing section (about how this might affect Tesla, which is already happened.)