The Market Is Almost Always Wrong About What The Fed Will Do

The Market Is Almost Always Wrong About What The Fed Will Do

3 months ago1 min

Last week the Federal Reserve (the Fed) tipped its hand that interest rate cuts are on the way in 2024, and investors are expecting them to be pretty aggressive. You can see that by looking at the price of fed fund futures – a financial contract that traders use to bet on what the central bank’s key rate will be at some specified date.

Right now, investors are expecting the rate to drop pretty dramatically: they’re betting that the first cut will happen as early as March and that by the end of 2024, the rate will be slashed by 1.6 percentage points to about 3.7%. That’s considerably lower than the 4.6% that the Fed is projecting.

Investors could be correct. But they usually aren’t. If you compare investor expectations (dotted lines) and what actually transpired (bold line), you can see that investors have historically been pretty bad at predicting the Fed’s next moves.

In 2008, for example, they completely underestimated the extent of the interest rate cuts that were coming (in fact, they were expecting hikes well before the crisis was over). From 2009 to 2016, they consistently predicted that the fed fund would rise well above 2% – but it never breached 0.25%. In both 2017 and 2022, they underestimated the extent of hikes that were coming, and in 2020, they underestimated the extent of cuts.

The lesson here is this: don’t accept what the market is pricing as gospel. Investors tend to be more wrong than right, at least where the Fed’s concerned. So don’t base your entire investment strategy on market expectations. Instead, keep your investments varied and your strategies agile.

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