Latest / Markets with Megan: A Quick Financial Markets Update / Rate Hikes and Market Moves: Analyzing the Fed's Strategy | Episode 173 | 09-16-24

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Rate Hikes and Market Moves: Analyzing the Fed's Strategy | Episode 173 | 09-16-24 · Markets with Megan: A Quick Financial Markets Update

• 0:00
  Megan Horneman: Well, the much-anticipated Fed Day is upon us.
• 0:03
  Megan Horneman: This week, on Tuesday and Wednesday, the Federal Reserve Committee will meet, they'll discuss monetary policy and then on Wednesday, we'll get announcements on what they are going to do with interest rates, as well as getting not only a press conference, but we will be getting new economic assumptions and also new dot plots where we can get a better idea of how many interest rate cuts the Fed officials are looking for over the next year.
• 0:28
  Megan Horneman: So in our weekly this week we just wanted to take a step back.
• 0:32
  Megan Horneman: Let's look at the tightening cycle that we've been through.
• 0:36
  Megan Horneman: What does history tell us around tightening cycles?
• 0:39
  Megan Horneman: And then what does it tell us around easing cycles?
• 0:42
  Megan Horneman: And then, specifically, what's priced into the market?
• 0:45
  Megan Horneman: So let's dig into some of these fun facts.
• 0:47
  Megan Horneman: And again, this is just looking at history as a guide.
• 0:50
  Megan Horneman: This is just history.
• 0:52
  Megan Horneman: All of the economic environments that surrounded different tightening cycles and easing cycles were all very different than they are today.
• 1:01
  Megan Horneman: But it is kind of a fun exercise to take a look at what history may tell us about some of these different tightening and easing cycles.
• 1:07
  Megan Horneman: So, first of all, the tightening cycle that we have been in, going back to 1945, it's the fourth longest stretch that a Federal Reserve has actually remained on hold.
• 1:20
  Megan Horneman: It's been about 14 months before they started cutting interest rates.
• 1:24
  Megan Horneman: This is also what we've seen is it's been one 14 months before they started cutting interest rates?
• 1:30
  Megan Horneman: This is also what we've seen is it's been one of the most aggressive tightening cycles, going back to 1945, the median average of interest rate hikes that we get in a tightening cycle is 225.
• 1:41
  Megan Horneman: But with this one we got 525 basis points in just about 17 months.
• 1:44
  Megan Horneman: This is one of the most aggressive, not only in that magnitude of rate hikes, but also in the length that they did this.
• 1:52
  Megan Horneman: There were only two other tightening cycles going back in history.
• 1:55
  Megan Horneman: That was in 1973 and 1980, where they were raising interest rates at a similar magnitude and as quickly as they did.
• 2:04
  Megan Horneman: Unfortunately, both of those did end up in deep recessions.
• 2:08
  Megan Horneman: Now is it time.
• 2:10
  Megan Horneman: If you look at real Fed funds rates, so typically this is the Fed funds rate, which takes into consideration inflation.
• 2:16
  Megan Horneman: Many would say that the Federal Reserve was behind the curve in hiking rates in the beginning of this anyway curve in hiking rates in the beginning of this anyway.
• 2:28
  Megan Horneman: Typically, the Fed starts raising interest rates in a tightening cycle when the real Fed funds rate is about 0.55%.
• 2:33
  Megan Horneman: So you have a positive real Fed funds rate, so they're going to typically have started raising rates then.
• 2:39
  Megan Horneman: But if you go back to when the Fed started raising interest rates in this cycle, that real Fed funds rate was actually negative 8.25%.
• 2:49
  Megan Horneman: So that's why you have many people saying that they were behind the curve already.
• 2:54
  Megan Horneman: Now, as being aggressive as they were, and with inflation coming down, they now have the real Fed funds rate at about 3%.
• 3:02
  Megan Horneman: If you look back at past tightening cycles, typically they start to you see that peak real Fed funds rate at about 2.3%, so that would argue that it is time to make some tweaks to monetary policy.
• 3:16
  Megan Horneman: On the negative side of this, though, typically the Fed's too late.
• 3:20
  Megan Horneman: 60% of the easing cycles that we've looked at since 1945 have resulted in a recession, because the Fed comes in after the economy's already slowing.
• 3:30
  Megan Horneman: So having an orchestrating a perfect soft landing is not the norm.
• 3:34
  Megan Horneman: It's actually the abnormally.
• 3:37
  Megan Horneman: Now the most important thing, though, whether they cut interest rates 25 basis points or 50 basis points at the meeting on Wednesday, what is the equity market pricing in?
• 3:44
  Megan Horneman: And one of the interesting statistics is that, if cut interest rates 25 basis points or 50 basis points at the meeting on Wednesday.
• 3:48
  Megan Horneman: What is the equity market pricing in?
• 3:51
  Megan Horneman: And one of the interesting statistics is that if you go back to all of the easing cycles, typically the S&P 500 is up only it's actually negative.
• 3:59
  Megan Horneman: I'm sorry.
• 3:59
  Megan Horneman: It's usually negative in the 12 months leading up to the first rate cut.
• 4:03
  Megan Horneman: Well, in the trailing 12 months through Friday, the S&P 500 was up 28%.
• 4:10
  Megan Horneman: So this would argue that the S&P is already pricing in these rate cuts and maybe a little too optimistic about it.
• 4:18
  Megan Horneman: Now, what does this all mean?
• 4:19
  Megan Horneman: In summary, our view, whether it's 25 or 50, what is the market pricing in?
• 4:24
  Megan Horneman: We can use history, we can look at this and it can be a fun exercise to see and try and have some consistency and data on where we may see equities go from here.
• 4:36
  Megan Horneman: But in reality, what we're looking at when it comes to investing is what is the economic environment?
• 4:41
  Megan Horneman: Right now, we're talking about a slowing economic environment.
• 4:44
  Megan Horneman: Inflation has gotten a lot better, but we talked last week about how some areas of inflation are still stubborn.
• 4:50
  Megan Horneman: We have political risks as well and we also have a consumer that is very stretched right now.
• 4:58
  Megan Horneman: So equities, where they are, are sitting not far from record highs.
• 5:02
  Megan Horneman: Valuations are stretched across many areas of the equity market.
• 5:05
  Megan Horneman: It may be pricing in too much optimism.
• 5:08
  Megan Horneman: This might be one of those situations where we sell on the actual news, so we expect volatility to pick up.
• 5:17
  Megan Horneman: What we're going to be looking at at this meeting on Wednesday, as we mentioned, dot plots what do they think GDP?
• 5:21
  Megan Horneman: What are they thinking about inflation?
• 5:22
  Megan Horneman: What are they thinking?
• 5:23
  Megan Horneman: Do they think GDP?
• 5:24
  Megan Horneman: What are they thinking about inflation?
• 5:25
  Megan Horneman: What are they thinking about the labor market?
• 5:27
  Megan Horneman: What are they thinking about the long-term neutral rate for the Fed funds?
• 5:32
  Megan Horneman: These are the things that are going to be market moving on Wednesday.
• 5:35
  Megan Horneman: That's all we have today.
• 5:37
  Megan Horneman: We'll be back tomorrow because we'll get the last significant piece of economic data, which will be the retail sales report, and then we'll be back on Wednesday to report our findings from the Fed's results from the meeting.
• 5:49
  Megan Horneman: Now, if you like this podcast, please subscribe, share this with friends or colleagues, hit that alarm bell that's at the bottom, and if you'd like a further history of our podcast, you can go to marketswithmegan dot fm.
• 6:00
  Megan Horneman: Thank you.