The Federal Reserve's Decision

Jerome Powell announced on Wednesday afternoon that the Federal Funds rate would increase to the target range of 4.75%-5.00%, a 0.25% increase. He also stated that higher rates may be needed to restrict the economy enough to bring inflation back to 2%.

That’s what happened. But how the market reacted is a different story.

The stock market moved lower, which is what I would’ve expected on this news. But the bond market still moved higher, by nearly a percent (which is an insane daily bond rally).

Of course you can tell exactly when the Federal Reserve’s press release went live (at 2pm ET) and when Jerome Powell started his press conference (at 2:30 ET).

Over the course of the last 2 weeks markets have been pricing in the chance of a rate pause, or a rate cut. All stemming back to the banking crises we are seeing.

Why are markets moving higher on materially bad news

But with a banking crisis shouldn’t that cause the market to move lower? But no, it all has to do with interest rates.

Interest rates are why markets fell in 2022, repricing of global assets on higher risk free rates.

While the Federal Reserve has remained firm on needing to raise rates to bring down inflation, they have a rich history of stating that they will continue to raise rates then suddenly reverse course.

A banking crisis is something to not take lightly, and they aren’t (they seriously considered a pause in this meeting).

That’s what the market had been pricing in, the chance that they would need to pause or cut rates, long in advance of when they stated they would need to do it.

I think the bond market took Jerome Powell’s tone at this meeting to suggest that they are at or near the peak of the rate cycle and could begin pricing bond yields down the the terminal rate.

What matters going forward?

There are three things that matter going forward.

1. Inflation. Every month this will be the number one thing to watch, if it continues falling it opens the window to lower rates sooner (without recession).
2. Employment. Again every month this comes out and it is the Fed’s other mandate. If this data starts to weaken the Fed may need to step in and save the labor market (by lowering rates).
3. Further crises. If the banking sector, or other sectors, continue to experience more crisis the Fed will have to inject more liquidity into the economy. There are two ways they can do that buying bonds or lowering interest rates (to calm the losses in the banks asset bases).