Fun times with the Fed

How will markets react? [Click to view in browser](. Good afternoon, In a short while, we’ll hear from Jerome Powell and his court on interest rates. Here’s what you can expect to hear and the likely reaction. Fed tools The Fed embarked on a three-pronged assault last year. - Lowered interest rates to zero - Bought heavy amounts of U.S. treasuries - Purchased corporate debt Interest rates are the weapon of choice wielded by the Fed to spur (or lower) demand). By lowering interest rates, banks are forced to lower their lending rates. That spurs borrowing and thus demand. Buying treasuries provide a similar impact, though more geared towards asset purchases like housing. Corporate debt purchases ensure companies can both sell their debt and get a decent rate on it (the Fed already completed this phase). Likely outcome No one expects rates to increase immediately. However, they could go from no rate increases through 2023 to a possible increase in 2023. What’s changed? The Fed expected higher price readings and lower unemployment in the first half of 2021. But recent inflation readings take things from ‘transitory’ to ‘stifling.’ Employment continues to improve, though not as much as they would like. Most market watchers expect the Fed to nod at the higher inflation in their statement as well as define a taper for treasury purchases. While these views are fairly widely held, markets may not be prepared. If you remember back to 2013, the Fed caught folks flatfooted with their taper announcement, leading to a ‘Taper Tantrum’ that saw a swift drop in the stock market. That isn’t as likely to occur here. However, a huge amount of the gains we’ve seen in the last year came from excess cash dumped into the system by the Federal Reserve. Pulling back on the juice means companies need to run on real growth, something rather questionable at the moment. What it means for you While it may not happen immediately, the announcement should lead to a pullback in stocks. Right now, there are few catalysts to send equity markets higher but many headwinds that could send it lower. Pulling out of bond buying, or even hinting at pulling out, one of the key drivers of higher prices, could send stock markets tumbling. And not just in the U.S. Should treasury prices drop, the cost of debt increases. With many global players denominating their debt in U.S. dollars, it makes it harder for them to repay their obligations. From a sector outlook, bank stocks benefit from higher rates while high-growth tech stocks might fare the worst. What’s unusual is that most investors normally hide from falling stocks in bonds. This time, we could see both decline in parallel. Our hot take Remember, cash is a position. More than anything, don’t get caught up in FOMO. Make a plan and stick with it. 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