Markets continue to misinterpret what the US Federal Reserve will do with regard to interest rates. I alluded to this last week but there remains a stunning divide in both communication and understanding between the two groups. It’s a recipe for disaster for investors who are unwilling to be patient.
The rally in markets over the last month or two hinged on the assumption that inflation was coming down rapidly, the economy was slowing, and all was returning to ‘normal’. After increasing rates by 0.25% last week, Fed Chairman Powell again handled his post-meeting press conference poorly and effectively poured fuel on the fire by using new language that investors instantly latched on to and sent markets instantly higher.
There are a few issues here. Firstly, he should know better by now. He’s seen his loose language create bear market rallies on multiple occasions. That said is that really his problem? How markets choose to interpret nuanced language? Secondly, investors have become so accustomed to reading so deeply into the underlying meaning of the words of officials that they make my year 12 English literature teacher look like a straight shooter.
And that’s part of the problem everyone is looking at all of this far too deeply as they try to make the situation fit the economic world they want. A world where making money was easy, a world where interest rates and inflation were constantly low. Everyone wants that and many have become accustomed to those conditions. If you take a step back everything is probably much simpler than we make it. While investors around the world look for every insight and clue to explain why everything could be bullish as it fits their narrative or strategy, they tend to lack objectivity and overlook what is right in front of them.
While Powell should know better in terms of choosing his words, his core message has really been the same for some time. If inflation remains high, rates will need to go up. Everyone looks to the Fed officials and those of other central banks to determine how ‘hawkish’ or ‘dovish’ they are in order to glean an insight into where rates may go. But the truth is that they don’t really know any more than anyone else. They have a view, which does matter as it pertains to their immediate decision, but ultimately it will be the economic data that will make these decisions for them over time.
This was never more evident than last week when Chairman Powell’s post-Fed meeting comments were interpreted as meaning rate increases may stop soon. Everyone was happy and markets jumped. But Powell’s view is really just the best guess of one man. The reality is different because what needs to happen will be determined by the economic data. And the reality was different. A couple of days later new data was released, a US jobs report. The Wall Street consensus forecast was for 190,000 new jobs created in the month of January. There was talk in the financial media that a lower than expected number of say 100,000 would really indicate that the rate hikes were nearly done.
However, that report showed that 517,000 jobs were created. A massive upside surprise. Suddenly nothing Powell said or didn’t say mattered. No one had forecast such a jump (of 20 or so Wall Street firms surveyed the estimates ranged between 130,000 and 305,000). Suddenly this single report changed everything. That job report means that unemployment in the US is now 3.4% the strongest since 1969. It also means that the labour market is still really tight and that means even more interest rate rises are likely required to cool off the jobs market.
In other words, if the jobs market is too strong it means wages will be driven up, potentially creating a wage-price spiral that will push inflation back up. So, the Fed will need to put up rates until it effectively creates higher unemployment.
Now there is new data coming out all the time, so you can’t become so obsessed with every data point announcement that you tie yourself up in knots just as some do with the words of Jerome Powell. But the data is what really matters, and ultimately the data will determine what Powell needs to do in the end regardless of the words he uses along the way or what he thinks or where he is leaning in his views.
Too many investors pin their hopes on an economic scenario evolving that aligns with their own greed or optimism. I would love to be more bullish in the short term but it’s not how the data adds up to me. The economic data will be the final decider of where interest rates go. Investors would be better equipped to look objectively at the numbers to navigate the reality of the situation. Hope is not a strategy.
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