about 1 year ago • 1 min
US Inflation seems to have peaked, and, if that’s the case, it’s good news for markets: it means the Federal Reserve (the Fed) is likely to start easing up on the aggressive interest rate hikes it’s been using to tamp down inflation. The problem is, a lot of investors are letting themselves get carried away with optimism.
This chart shows where investors and economists see the fed funds rate moving over the next year or two – and generally, they see it peaking at close to 5%. To put into context: the fed funds rate is currently 4.25% to 4.50%. So that implies that they don’t see the Fed hiking by more than 0.5 percentage points in total this year. And – as if those expectations weren’t optimistic enough – they also see the Fed beginning to cut rates by midyear.
Optimism isn’t necessarily a bad thing, except when it goes against the facts and affects market prices. In their latest meeting minutes, Fed officials said they need to see “substantially more evidence” that inflation is on a sustainable downward path toward 2% before they change course, or “pivot”. And that might not happen for a while.
See, expectations are important in financial markets: it’s not the actual data that moves markets, it’s the surprise in the data. As an investor, you want to invest when markets are very pessimistic, because the potential for a positive surprise then is greater. Warren Buffett famously said, “be fearful when others are greedy, and greedy when others are fearful.” In this case, the market isn’t fearful enough, and unless expectations are reset, a bull market bounce is unlikely.
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