Last week, the Fed not only raised rates by another 25 basis points (to 4.75%) but re-iterated its expectation that at least one more rate hike was yet to come and rate cuts over the second half of the year were not likely. The market reaction was to price in 25 basis point rate cuts at every meeting in the second half of the year.
More Context: Prior to the emergence of the issues in the banking sector over the past two weeks, the bond market had moved toward the Fed’s view that bringing inflation under control would require rates staying “higher for longer.” While the Fed sees them as isolated incidents, banking-related stresses have led to a quick pivot from the market. The 2-year T-Note yield, which had risen to above 5% earlier this month, finished last week at 3.8%, its lowest level since September. The challenge for investors is that despite near-term rallies in both bonds and stocks, longer-term down-trends remain intact. Bonds are rallying despite hawkish guidance from the Fed and stocks have rallied despite deterioration beneath the surface.
In this week’s Market Notes we approach the market as we would an impressionist painting, taking a step back to maintain perspective rather than leaning into the brush strokes and getting lost in the noise.
Financial stress has emerged, with the St. Louis Fed’s index jumping to its highest level since COVID and, prior to that, the 2008 Financial Crisis. The Fed at this point believes that it can act as lender of last resort to alleviate those stresses while not pivoting from its focus on inflation.