Markets could have calculated the US Federal Reserve incorrectly.

The market’s decision to switch to a more forgiving Fed may have been a grave error. Several Fed governors and board members have stated publicly this week that rates will still need to rise significantly and remain there for some time in order to bring inflation back to their 2% target.

The Fed Funds Futures were the first to respond to that message, which appears to be spreading throughout the markets. The biggest change seems to have happened just last week, right before the Fed’s initial rate cut.

The Fed Fund Futures were pricing in the first rate decrease in March 2023 last week, but that date has since been moved to May 2023. The Fed Funds Futures also experienced a top rate of 3.25%; rates are currently anticipated to peak at 3.45%. If the Fed gets its way, rate cuts will be delayed even further and interest rate expectations would rise.

Fed Funds

Fed Funds

The market had convinced itself after the FOMC meeting that a data-dependent Fed would result in a more dovish, stock market-friendly Fed, so even while it may be a minor movement, it is a shift nonetheless. The Fed may need to raise rates much higher and maintain them high for longer than anticipated, according to the Fed governors’ tone since the meeting.

Due to the erroneous perception of the market, recent gains in stocks, particularly growth-oriented firms, have been driven by easing financial conditions and declining real yields. Real yields should climb as financial conditions start to tighten again as the market reprices for a Fed that isn’t expected to be done hiking rates anytime soon.

QQQ And TIP Daily

QQQ And TIP Daily In times of tighter financial conditions, margin levels would be reduced, while increasing real yields would act to bring down the PE ratio and stock valuations. The QQQ ETF and the TIP ETF have a strong correlation, with the latter indicating higher real rates when the former is declining. The QQQ ETF has a history of doing so, so if the TIP starts to trend lower once more, it would seem that eventually the QQQ should do the same.

As long as the Fed keeps sending hawkish signals, the current rate reduction and easing of financial conditions are unlikely to sustain. Additionally, the Fed requires financial conditions to tighten, not ease, in order to reduce inflation. When a result, as circumstances loosen, the Fed is working against that goal, making the current surge seem ludicrous on a number of different levels. Rising share markets alleviate banking conditions but eventually making the Fed’s task more difficult. In the long run, it might even mean that the Fed needs to raise rates even further.

So yes, equities can rise farther, but at their own risk.

Disclaimer: Charts are being used with Bloomberg Finance L.P.’s permission. This report includes unbiased analysis that should only be used for informative and educational purposes. Michael Kramer works for Mott Capital Management as a member and investment adviser representative. Mr. Kramer is not connected to this business and does not have a position on the board of any affiliate that issued this shares. This analysis or market research contains only Michael Kramer’s opinions, which he has not shared with any third parties. Any opinion, point of view, or forecast made by Michael Kramer should not be construed as a specific solicitation or recommendation to buy, sell, or use a particular investment strategy. Although Michael Kramer bases his analysis on data and independent research that he believes to be trustworthy, neither he nor Mott Capital Management can attest to its accuracy or completeness, therefore it shouldn’t be taken as gospel. Any information supplied in Michael Kramer’s assessments is not subject to any responsibility to be updated or corrected. Statements, recommendations, and opinions made by Mr. Kramer are subject to modification at any time. Future outcomes cannot be predicted based on past performance. Neither Mott Capital Management nor Michael Kramer provide any profit or outcome assurances. You must be aware of the actual risk of loss while implementing any investing advice or strategy recommended in this report. The prices or values of the investments or strategies suggested could change. The investments or tactics discussed in this analysis might not be appropriate for you. This information is not intended to be a recommendation for you and does not take into account your unique investment objectives, financial position, or needs. You must independently decide the investments or techniques to use for this analysis. The adviser will offer a list of all suggestions made in the previous year upon request. You should carefully evaluate whether the information in this analysis is appropriate for your situation before acting upon it, and you should strongly consider receiving advice from your own financial or investment consultant to assess the suitability of any investment.