The economy’s too hot and too cool in all the wrong places – so if the Federal Reserve (the Fed) wants to hit the right temperature, it’ll need to get its tactics just right.
✍️ Connecting The Dots
You’d think the economy couldn’t be much icier, what with Big Tech companies slashing hundreds of thousands of jobs and big banks crumbling by the day. The Fed, though, is still pushing economy-cooling interest rates higher. But despite the way it looks, the central bank isn’t trying to freeze the country over: rampant inflation’s been so hard to tame that the Fed’s being forced to make incredibly difficult trade-offs at a time of extreme economic uncertainty. On one hand, it needs to raise rates to cool off demand and keep inflation in check. But on the other hand, it has to be careful not to trigger a financial meltdown or plunge the economy into a deep recession. That’s a hard, high-pressure tightrope to walk.
The good news is that so far, stocks have shown incredible resilience. The notion that stocks would be able to withstand the shock of interest rates catapulting from 0% to almost 5% in the space of a year would have been impossible to swallow just a few years ago. But we’re far from out of the woods, and the million-dollar question is whether stocks can sustain this hardiness, or if it’s the calm before the storm. And given the long lags between rate hikes and their impact on the economy, and the complicated relationships between the economy and financial markets, there’s almost no telling which way it’ll go.
The best strategy, then, might be to stay aware of the different scenarios, and let evolving data and price movements help you decide which outcome which outcome seems most likely. And with companies gearing up to report their first-quarter earnings, you might soon have new valuable information to help you make sense of it all. See, economic data’s improved since firms last expressed caution around the outlook – but those layoffs won’t have happened for no reason, so you’ll want to discover whether something scary is lurking beneath the surface.
1. The details might be interesting, but you need to step back if you want the full view.
As humans, we have an insatiable need to make sense of everything we see. That's how we feel like we're in control. Problem is, we can get so bogged down in the tiny details that we miss the bigger picture. So sure, we could try to explain each event away as an isolated incident, but when you step back and take a look at the more general trends, the image becomes pretty clear: the economy is slowing down, our financial system is struggling under the weight of higher interest rates, and the job market might not be as strong as we've been led to believe. And in an environment like that, you could do worse than being extra cautious.
2. Markets can be moody, but you can’t just shrug off those tantrums.
The Fed’s not the only one with a tough job on its hands: investors are playing a high-stakes game of three-dimensional chess with this market, where every move opens up a whole new world of possibilities and potential outcomes. And it's not just about the hard numbers, either. The mood and emotions of the market can have a massive impact on prices, which in turn affects the economy, and then feeds back into the market. That feedback loop makes predicting the next change a real headache, so if you’re feeling a little lost, your best bet might be to make sure your portfolio is truly diversified. After all, that’s the only free lunch in finance.
🎯 Also On Our Radar
Banks might be failing on both sides of the Atlantic, but the main narrative’s still that risks are contained. Still, you should keep watching – very closely – for possible risks of contagion. And with the cost of insuring against a default of Deutsche Bank climbing to new heights and bank indexes plummeting, it’s hard to say that the scene’s encouraging.
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