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Here’s why the market may be wrong about the Federal Reserve and interest rates

A trader on the floor of the New York Stock Exchange.

Source: NYSE

The aggressive stock market backlash on Monday came despite concerns that investors were not yet aware of how quickly the Federal Reserve Board could start raising rates for a Wall Street company.

After being hit in the last three trading days of last week, Wall Street is back with a move to raise the Dow Jones Industrial Average by more than 1.5%.

“The market is back in a comfortable mode,” Mohamed Ellerian, Allianz Chief Economic Advisor, told CNBC’s Squawk Box. “Growth is strong. They still believe inflation is temporary. They believe the Fed will taper relatively slowly. [monthly asset purchases], And that’s why you’re looking at it. ”Inventory is high.

According to Bank of America credit strategist Hans Mikkelsen, that optimistic view of the Fed’s policies is wrong.

The Federal Open Market Committee closed last week with authorities showing that there will be two rate hikes in 2023, faster than the market expected.

But Mikkelsen’s view is that monetary tightening policies may come sooner.

“I hope the Fed will soon begin its tapering. [quantitative easing] Buy and start raising interest rates sooner than expected, and most importantly, much earlier than the current market price. “

According to bank analysis, the Commission was a “two point”, a forecast of two members of the 18 Commission, and did not make the first rate hike in 2022. Members saw three hikes in 2023.

In summary, members’ sentiment about where the policy should go provided a significant departure from what was historically an easy federal government.

Mr Mikkelsen said the credit market, which has cut interest rates significantly despite the Fed’s hawkishness, is misleading the central bank in which direction. From a market perspective, the Fed is only 41% likely to raise rates by July 2022, according to CME’s FedWatch tracker.

“As interest rate strategists continue to point out, the main mis-pricing in the interest rate market is not tapering, not the timing of the first rate hike, but the pace of subsequent rate hikes, which is too shallow. . Past hiking cycles. “

In effect, the Fed has already begun to taper off with a move to unleash a small portfolio of corporate bonds purchased during the Covid-19 pandemic, Mikkelsen said. The move was “100% unexpected due to the Fed’s poor track record of selling assets, which, even if it means contrary to market expectations, keeps the Fed out of a very simple monetary policy stance. It shows that you are feeling more and more bold. “

Fed changes

Fed officials have shown that the landscape is actually changing, as reflected in the Dot Plot forecast released Wednesday.

St. Louis Fed Governor James Bullard shook the market on Friday when he told CNBC that he was one of the FOMC members who believed the 2022 rate hike was appropriate. Bullard is not a voter this year, but will be a voter next year.

However, Dallas Fed President Robert Kaplan said Monday that he was focusing on slowing the pace of bond purchases.

“We want to act early on the purchase of assets, not later,” said Kaplan, who gave a presentation in collaboration with Bullard. “Then, after 2022, we will make decisions on the additional steps needed.” Said. According to the official financial institution forum. “But I think it’s the timing and adjustment of these purchases that matters today and in the short term.”

Both officials pointed out that the economy had progressed and confirmed why inflation in recent months could be a little more tenacious than the Fed expected.

“Supply and demand imbalances, some of which we believe will resolve in the next 6-12 months,” Kaplan said. “But we believe that driven by many structural changes in the economy, some of them are likely to be more sustainable.”

For example, he said the transformation of the energy industry into sustainable electricity, a key component of the Kaplan district, has contributed to longer-lasting inflationary pressures.

Bullard talked about the evolving labor market as an important consideration for future Fed policy.

“We need to be prepared for the idea that inflation carries an upward risk,” he said. “Sure, the anecdotal evidence that this is a very tight labor market is overwhelming.”

If these inflationary pressures are hotter than federal officials think, it will force them to tighten policy faster than they want. It will hurt the stock market and the wider economy, and they both rely on lower rates.

Tight Federal Reserve spends have skyrocketed over the past year, raising the cost of borrowing for governments that want to do more with their infrastructure.

“Inflation is temporary now, but if we cover it with even greater stimulus, we risk making it permanent,” said Joe Labolguna, chief economist at Natixis in the Americas. Said. “So you’re in a really tricky place. I think the Fed’s best approach is to say the least.”

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Here’s why the market may be wrong about the Federal Reserve and interest rates

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