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The Fed has a problem in that it says one thing, and the markets want to hear another. “The bottom line is the markets just aren’t buying what the Fed is selling,” said Diane Swonk, chief economist at KPMG. “That ups the ante on the Fed to go further and be more hawkish.” Stocks were sharply lower Thursday, and bond yields retreated as investors considered the hawkish tone of the Fed’s message that it will keep rates higher for longer. Markets had flip flopped Wednesday afternoon, after the Federal Reserve released its policy statement and new interest rate and economic forecasts. The Fed raised its benchmark interest rate by a half percentage point , and it is now targeted in a range between 4.25% and 4.5%, a 15-year high. The Fed also signaled it would raise its funds rate to as high as a range of 5% to 5.25% next year. “[Fed Chair Jerome] Powell didn’t get what he was after. There’s clearly a gap between what financial markets want to believe and what he wants to say,” said Swonk. “The speech was hawkish and the Q and A was dovish.” She said the Fed seems determined to hike rates until it stops inflation. Swonk noted there is agreement among Fed officials to drive rates higher, and most officials forecast an end point for rates above 5% in 2023. But, markets just don’t believe it. “They can’t have financial markets easing while they’re tightening. If they do, they have to do more,” Swonk said. Fed funds futures Thursday showed a high rate of 4.89% by next May, still below the Fed’s target. The Fed had released its interest rate forecast with its so-called dot plot, a chart showing the anonymous targets of different Fed officials. “The dot plot guided people higher, and it’s almost like the market didn’t take the bait,” said Peter Boockvar, chief investment officer at Bleakley Financial Group. He noted the 2-year yield, which most tracks Fed policy, drifted lower after the Fed meeting. It was at 4.22% on Thursday. “The market is basically saying 4.75% to 5% is where the Fed ends,” said Boockvar. “That’s just another 50 basis points.” While the market doesn’t appear to believe the Fed can raise rates as high as it wants to, Boockvar said investors may now be listening to the warning that rates will be higher for a longer period. “I think based on this morning’s action, Powell’s succeeding in convincing people that rates will stay higher for longer,” said Boockvar. “Keeping rates high for longer is a form of tightening. Every month that goes by means there’s somebody’s debt that matures that’s going to be needed to be refinanced at a higher rate.” ‘Between hope and fear’ The progress on inflation appears to be one area where markets and the Fed don’t see eye to eye. Strategists were surprised the Fed did not mention there was improved inflation data until Powell spoke, while markets have latched on to every positive move lower. In his post-meeting briefing, Powell acknowledged the cooling of inflationary pressures, but he added the Fed needs to see more substantial evidence that inflation is fading. The consumer price index for November was up 7.1% on an annual basis, down from 7.7% in October and better than economists expected. Some strategists said the Fed’s determination to keep hiking rates also spurs worries that it could cause more damage to the economy. In the bond market, strategists say recession concerns are clearly holding back interest rates. “I think investors continue to be stuck somewhere between hope and fear,” said Michael Arone, chief investment strategist at State Street Global Advisors. “They continue to be hopeful that the Fed will turn dovish, and I think they continue to be fearful they will raise rates too far and ultimately break something or put the economy in a recession.” DoubleLine Capital CEO Jeffrey Gundlach said after the Fed’s meeting Wednesday that the central bank should stop raising rates since the economy is already weakening. “I think there has been some progress on inflation,” Gundlach said on CNBC’s ” Closing Bell: Overtime .” “Nobody’s really talking about all of these runaway price increases anymore. With the economy weakening, I think the inflation rate is going to fall faster than most economists do.” Stocks were higher ahead of the Fed’s 2 p.m. ET statement Wednesday, and sold off before recovering from their worst levels on the day. The 10-year Treasury yield was at the high of the day just after the Fed’s statement and then declined going into Powell’s briefing and into the end of the day. Yields move opposite price. The 10-year was at 3.48% Thursday. One problem for the Fed is that its terminal rate forecast, at 5.1% in 2023, is followed by a forecast of a rate in 2024 that is a full percentage point lower. Boockvar said the futures market is pricing in a rate below 4% for April, 2024, and has priced in a full rate cut for the end of 2023. Mark Cabana, head of U.S. rate strategy at Bank of America, had predicted just what the Fed forecast Wednesday. “The market is basically thinking you can say higher for longer all you want. We don’t believe it. We believe the second you stop hiking, six to nine months later you are going to start cutting,” he said ahead of the meeting. “As long as the Fed keeps those cuts in their forecast … higher for longer is not credible in the market’s mind.” Citigroup economists also noted how the Fed failed to drive a tougher tone on policy Wednesday. They titled their note on the Fed meeting, “Hawkish message fails to land with markets.” In it, they wrote that “Powell and FOMC projections were about as hawkish as could have been reasonably expected.” Andy Brenner of National Alliance wondered whether the Fed was done with its rate hikes. “While we would like to say yes, the Fed statement was too hawkish to make that determination at this time.” He added that the dollar, which also fell Wednesday, acts as if the Fed is finished. “We have seen this before,” wrote Brenner. “Powell tries to make everyone believe that he is a hawk…but once he goes off script the world can see is is a dove in wolf’s clothing.”
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