Markets May Have Miscalculated The U.S. Federal Reserve

• Following FOMC meeting,does atfx deposit money into a private account markets have been pricing a kinder Fed
• But Fed governors and board members have been pushing back
• May turn out that markets have made a massive miscalculation

The pivot to a kinder and gentler Fed may have been a giant mistake by markets. This week there has been a slew of Fed governors and board members who have come out and noted that rates will still need to go much higher and stay there for some time to bring inflation back to their 2% target.

That message appears to be making its way through the markets, with Fed Funds Futures being the first to respond. Just over the past week, the most notable shift appears to have occurred around the timing of the Fed's first rate cut.

Last week, the Fed Fund Futures were pricing in the first rate cut in March 2023, which has shifted to May 2023. Additionally, the Fed Funds Futures saw a peak rate of 3.25%; now, rates are expected to peak at 3.45%. If the Fed has its way, it means rate cuts continue to move further out in time, and expectations for rates move higher.

Fed Funds

It may be a subtle shift, but it is a shift because the market had convinced itself following the FOMC meeting that a data-dependent Fed would lead to a more dovish, stock market-friendly Fed. The tone coming from the Fed governors since the meeting suggests the exact opposite: a Fed that may need to raise rates much higher and keep those rates high for longer than expected.

A recent rally in stocks, specifically growth names, has come from easing financial conditions and falling real yields because of the market's distorted view. However, as the market begins to reprice for a Fed that isn't likely to be finished raising rates anytime soon, financial conditions should start to tighten again, and real yields should rise.

QQQ And TIP Daily

Tighter financial conditions would result in margin levels being cut back, while rising real yields would work to reduce the PE ratio and valuations of stocks. The TIP ETF, which, when falling, indicates real yields are rising, has been highly correlated with the QQQ ETF. Over time, the QQQ ETF tends to follow the TIP, and if the TIP begins to move lower again, it seems that ultimately the QQQ should follow the TIP down.

The recent decline in rates and easing financial conditions aren't likely to last as the Fed continues to deliver a more hawkish message. Additionally, the more conditions ease, the more it goes against what the Fed is trying to do, which is to bring down inflation, and to do that, the Fed needs financial conditions to tighten, not ease—making the recent rally seem absurd on many different levels. The rising equity market helps ease financial conditions and ultimately complicates the Fed's job. It may even mean the Fed has to raise rates even more in the long run.

So yes, stocks can continue to rise, but they do so at their peril.

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