Connecting The Dots
My eldest son recently turned seven. Because of COVID restrictions, he's now missed out on having a birthday party with his friends for his 6th and 7th birthday. He's okay with it. It's probably more of an issue for me and my wife, I don't know why. I guess we just want to be able to see him really happy with his friends.
He's already listing the things he wants for his 8th birthday. And every time it's something different. I try and explain to him that so much can happen between now and then, but I simply concede and just nod. I mean, what else can I do? He'll forget about it anyway.
Every three months since 2012, the US Federal Reserve officials estimate what the federal funds rate should be for each of the next three years and the long term - think about it like our cash rate. They then release the famous dot plot.
Here is the latest dot plot. Each dot represents a committee members' estimate for where the federal funds rate should be for each respective period.
And this my friends, is why the stock market is choking on it's food right now. Federal Reserve officials signalled they expect to raise interest rates by late 2023, sooner than they has anticipated in March. Their median projection showed they see lifting their benchmark rate to 0.60% from zero by the end of 2023. They had previously expected to keep rates steady, with rates moving in 2024. Let me say that again, they see rates moving up from there they are now, near zero, to 0.60%!
This is the bad news you are being fed. This is why investors are selling their stocks. Because right now folks, the economy is stabilising. Right now folks, the economy is strengthening. Did you think zero rates were here forever? Did you think the Fed was going to be buying bonds forever? Sir, go home, you are drunk.
Meanwhile, in the depths of the bond market, the US 10 year has dropped from 1.75% at the beginning of the quarter to 1.43% today. Meaning, the bond market is calling the Fed's bluff - it's expecting rates to decline and/or remain low for the next 10 years. What the!?
Investing based on the latest headline is a recipe for disappointment. Newspapers report what happened, while markets report on what is going to happen. The bond market had already priced this in months ago. Oh, you don't remember the 20%+ decline in long-term treasuries earlier this year? Stop reading the headlines, and bury yourself in history books.
Just like my 7 year olds' wish list for his 8th birthday, the Fed's opinion of where interest rates will be or should be will also change. Predictions are hard. Especially when they're about the future.