Federal Reserve vs Financial Markets: the great divergence

One is certain, the other isn’t, no one is right

The Federal Reserve isn't very good at making predictions about the economy (very few people are). But that doesn't prevent them from making decisions that will have big consequences.

And since everyone knows that, the financial markets will often try to anticipate where the Federal Reserve is going. Which means the Fed really have three super powers:

• They can control short term rates.

• They can affect liquidity by printing money.

• They can give guidance about what they think about doing (and let the market do the job for them).

That last point is why you really want to pay close attention about the official communication coming out of the FOMC. When the Fed speaks, the market listen.

The problem is when the Fed says something and the market hears something else... 

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Federal Reserve vs Financial Market: the great divergence

The takeaway

Wage growth is too strong. That’s a road block on the way to the 2% inflation target. That’s why the Federal Reserve need to maintain a restrictive monetary policy. 

But the financial markets are firmly in the camp of “soft landing achieved”.

We think that’s a dangerous situation. The market is priced for perfection. But the dangers of a recession are not behind us. 

Follow the trend but be cautious about not getting caught by FOMO (I sound like the SEC now…) there is a risk of sharp reversal in case of bad economic news.

The root cause of inflation is still there