Four things caught my eye with yesterday’s release of the January Fed Minutes: (i) worries over tariffs and their impact on inflation; (ii) some members suggesting the fed funds rate is now close to neutral (not the majority); (iii) concerns over the pace of balance sheet reduction targets; and (iv) inflation needing to come down more before lowering rates further. Makes sense to me… But I can’t help but wonder when Powell ran a victory lap last September – whether it was premature.
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The Market’s Addiction
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.
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?