The Markets are Hopeful

Since the beginning of the year, both stocks and bonds have performed well. In fact, if you annualize the first month of performance you would have a 1-year performance of 52.68% on stocks and 34.68% on bonds.

Of course, returns of that magnitude are unlikely to persist year round, the market seems to think there are better days ahead of us.

And most of those better days have to do with inflation and monetary policy.

The market implied path of interest rates has shown us that rates are likely going to plateau or fall in the coming year.

The market implied effective rate continues to fall on fears of recession and on the fact that inflation is falling.

The next 3 charts I don’t expect anyone to be able to interpret but I am going to try and break them down as simply as possible.

For the February FOMC meeting, next week, the market nearly expects a 100% chance of a 0.25% hike, the same as the Fed.

For the March FOMC meeting, the market is saying there is about an 80% of another 0.25% hike, the same as the Fed.

But here is where the Fed and the market diverge. On the last chart, it shows what the market is projecting for the end of the year. The market says that there is over a 50% chance that interest rates end the year at or below where we started, and a nearly 50% chance that rates aren’t hiked if they don’t fall.

Either of those scenarios is great for both the stock and bond markets. The only problem is that it isn’t what the Fed tells us, although the Fed has a rich history of doing 180-degree pivots.