Friday's Market Minute: Stocks and Bonds Paint a Very Different Picture

Equites continue to rally since the Federal Reserve hinted that the aggressive series of rate increases is nearing an end. At first glance, markets appeared indecisive after the statement came out but took the press conference as dovish. Looking past anything slightly more hawkish such as the need for more substantial evidence that monetary policy is appropriately restrictive, Powell’s acknowledgement that the disinflationary process has begun was an obvious part of his commentary that the bulls forcefully latched on to. 

Despite another 25-basis point hike expected in the March FOMC meeting, investors have been acting as though the Fed is ready and willing to pivot towards monetary accommodation sooner rather than later. The S&P 500 is up nearly 20% from the October lows, yet the 10-year Treasury yield is down nearly 20% and the U.S. dollar index is down over 10% suggesting the economy and corporate profitability may continue to erode. Market participants also believe inflation will decline more quickly than the Fed is currently thinking. Futures markets are pricing in roughly 50 basis point of rates cuts by the end of 2023, while the Fed target remains at 5.1%.

 Disregarding the equity market, bond markets are not so bullish on the economy. As the Fed Funds rate inches higher, the two-year Treasury yield continues to fall. This implies the Fed is near the so called “pause,” and potentially at risk of overshooting rates to the upside. Another cautionary indication is the spread between 3-month and 10-year rates which has not seen this level of inversion since before the 1982 recession triggered by tight monetary policy in an effort to fight mounting inflation.

The Fed expressed concern about the risk of reaccelerating inflation, which is justified considering how far inflation is from the target. Powell continued to stress the need for further rate rises to bring inflation firmly under control and said policymakers would not become “complacent” despite encouraging recent data. In conjunction with how the policy-sensitive two-year yield has been falling, the Fed is clearly telling markets that they are willing to overshoot to make sure they conquer inflation.

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