Investors may be getting the Federal Reserve wrong, again
Federal Reserve’s policy rate, plotted as a thick line against time on the x-axis. Branching out from this trunk are hairs: fainter lines showing the future path for interest rates that the market, in aggregate, expects at each moment in time. The chart leaves you with two thoughts.
The first is that someone has asked a mathematician to draw a sea monster. The second is that the collective wisdom of some of the world’s most sophisticated investors and traders is absolutely dreadful at predicting where interest rates will go. Since inflation began to surge in 2021, these predictions have mostly been wrong in the same direction.
They have either underestimated the Fed’s willingness to raise rates or overestimated how quickly it will start cutting them. So what to make of the fact that, once again, the interest-rate market is pricing in a rapid loosening of monetary policy? This time is different, and in an important way. A year ago investors betting that rates would soon be cut were fighting the Fed, whose rate-setters envisaged no such thing.
Then, in December, the central bank pivoted. Rate cuts were now being discussed, announced Jerome Powell, its chairman, while officials forecast three of them (or 0.75 percentage points’ worth) in 2024. The market has gone further, pricing in five or six before the year is out.
It is, though, now moving with the Fed, rather than against it. Mr Powell, in turn, is free to make doveish noises because inflation has fallen a lot. Consumer prices rose by just 3.4% in the year to December, compared with 6.5% in the year before that.
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