Wrong! The Fed Won't Ease When You Think They Will
The market rallied significantly yesterday on the increase in Fed Funds by only .25%. This is a decline from the .5% that had been the norm.
But Fed Head Jay Powell said that this level of increase would be appropriate for some time. But for how long.
The market thinks that the increases will continue into the middle of the 2Q2023. The market then thinks that the Fed will actually start easing.
But I don't think so.
There are several reasons:
- Inflation will stop going down
- Unemployment will be flat
The Fed, by law is supposed to focus on only two considerations: inflation and employment.
The easing inflation was the reason why the Fed said they are slowing the rate of Fed Funds increase.
But here is the problem.
Raw material prices have stopped easing and are now flat. It was the decline in raw materials, particularly gasoline, and used car prices that were the main drivers of the decline in inflation. Now, used car prices are still declining but other raw material prices are not declining any more. That means that the volatile parts of inflation are no longer moving in the right direction.
At the same time, stick prices, like rents and wages are increasing. They will not come down until late this year at the very earliest.
So headline inflation won't be coming down anymore. That will lead the fed to keep increasing Fed Funds by 25 bps for month after month after month.
At the same time, the recession is starting to bite but not much. So unemployment rates will remain low. It won't be until the 2H2023 when we will start to see the recession bite enough to cause non-farm payrolls stop rising.
So the Fed will not ease until late this year at the earliest.
That will shock the market because they are looking for Fed easing earlier
I remain long the stock market and gold but will bail out probably later in the 2Q2023 when the market realizes that the Fed will not ease in the 2Q2023.