A macro-matrix with considerable risks

The Federal Reserve and Chairman got it exactly right in their decision and accompanying statement.

They had quite the tight rope to walk. Gingerly crossing a terrain of still high inflation and a banking crisis in an economy already slowing.

Everyone is talking about what an aggressive rate cycle this has been, but such arguments do not take into account that the baseline from whence we came was near-zero.

Hence, to get back to anywhere near a neutral monetary policy setting, let alone restrictive, was going to take quite a strident effort.

The Federal Reserve was badly at fault in not recognising the tsunami of inflation that would accompany both the Covid-crisis and post-Covid boom, let alone further supply shocks through war and sanctions. It has however now largely caught up.

In a historical sense, I would argue that current rate levels are about right, but if anything are still a little stimulatory. This you do not want in a persistent high inflation environment such as the one we have now.

This is why it is perfectly correct that the Federal Reserve has maintained a clear tightening bias without committing to an actual pause. Though it has certainly left the door open to remain at the current setting at the next FOMC.

What markets have mis-priced is that the interest rate picture is much bigger than the past decade. What was average or normal/neutral over the past decade, is not what will be considered neutral over the coming decade. Moving forward the new normal is now, on this reset most likely 4.5%, but inflation is too high and this is why the Fed Funds Rate is now at 5.25% and maintains a further tightening bias.

This is actually very appropriate policy and the Fed should be congratulated for becoming nuanced in their approach in the current mix of persistent inflation, growth slowing and a burgeoning banking crisis.

On the latter point there is no solution to the accelerating banking crisis other than Janet Yellen cancelling the latest policy on depositor safeguards. This is unlikely. So the banking crisis can only be expected to deteriorate further.

Troubling for the Fed would be that we could well see a severe banking crisis while inflation remains high. What to do? The Fed probably has good a mix as can be mustered right here now. However this remains a macro-matrix with considerable risks. Especially, with regard to inflation.

If there is another Fed rate move this year, it is likely to be higher. Not lower.

We have said from the very beginning that talk of a Fed pivot was absolutely nonsense, and so it is.

This is why the stock market fell and will likely keep falling. The market was pricing a firmer pause tone in the statement, as well as rate cuts this year?

The reality moving forward is actually something quite different.

The Fed Funds Rate is staying here, or higher for the next 12-18 months. While the economy will continue slowing.

In other words, continue to play defence of your investment portfolio.