The Federal Reserve vs. what the Markets are Pricing
The Federal Reserve vs. what the Markets are Pricing
Following months of monetary policy tightening, the world has now firmly placed its focus on when the Federal Reserve will finally “pivot” to a more neutral stance.
The tightening has been fast and substantial – we have gone from zero rates to 3.75%-4.00% within ten months – and another 50bp hike is expected for the December meeting next week. The main question now is twofold:
- * How high will the peak Fed Funds rate be
- * How long will rates stay at that peak rate
Fed Fund futures are currently pricing the peak rate at roughly 50bps higher following the December expected 50bp hike. More importantly, futures are pricing only a couple of months of flat rates, before nearly 50bps cuts by January 2024:
In the previous FOMC meeting, Jay Powell confirmed that the pace of rate hikes would likely decrease going forward. The markets took that confirmation as dovish, even though the futures market had been broadly pricing 50bps beforehand anyway.
Could Powell hike 50bps in December and then only deliver 50bps more afterwards? This could well be the case, but the risk is to the upside in my opinion. Could the Fed stay on hold for only 2-3 months and then start cutting rates? Potentially yes, but again I think the risk is to the upside.
When you are trading yields or risk assets, the Fed’s monetary policy will have a profound impact on prices. Therefore, it’s important to understand what Fed scenario will be favourable to your positions and what will be negative. Higher US yields almost always mean a stronger US Dollar and lower levels in bonds (by definition), equities, cryptos and other risk assets.
I think that the risk is for the market to first reprice a higher Fed Funds terminal rate and a longer plateau of flat rates, before the rate cuts. There is a heightened risk of this following next week’s Fed rate decision, and it could be the main market theme going into early 2023. Having said that, inflation will likely drop significantly in late Q1 2023, simply due to the way it’s calculated (we will be comparing prices to the Feb-Mar 2022 period where we saw a massive spike higher).
Ultimately, with inflation dropping fast, the Federal Reserve will then “pivot” to a neutral stance, and potentially deliver more easing – perhaps even confirming the market’s current pricing of a quick reversal from hikes to cuts.
And that brings us to an important point about markets: you might have the correct view, but market movement can stop you out before it materializes.
Have a plan: understand why you are taking a trade, what the trigger to enter the trade is, and most importantly know where you are wrong. Adjust position sizing according to prevailing market conditions, and always be disciplined & vigilant with your stops.
============================================================
TRADER FUNDING PROGRAM by Forex Analytix – Supercharge Your Trading!
If you want to access a live trading account, visit https://traderfundingprogram.com/?ref=stelios
Pass the assessment and access live funds!
20221208
