Thoughts on Central Banks

Michael Rudd, CFA | President, CEO & Portfolio Manager

Three weeks ago, we identified three areas of focus that we will be discussing this spring (the economy, employment and inflation). This week, we discuss the US Federal Open Market Committee (FOMC) and how it might approach its positioning in the coming months. One of the most difficult parts of finance is to predict what the FOMC will do and how “the market” will react. This is essentially one equation with two unknowns and tends to cause a lot of confusion for investors. It is also probably not predictable with any level of consistency. We note two quotes below that we thought were interesting from this perspective. One from Jamie Dimon, CEO of JPMorgan and one from Jerome Powell, US Fed Chair.

“And while this is nothing like 2008, it is not clear when this current crisis will end…. it will clearly cause some tightening of financial conditions as banks and other lenders become more conservative…We are seeing people reduce lending…. It won’t necessarily force a recession, but it is recessionary.” – JPMorgan Chase ($JPM ) CEO Jamie Dimon

“You will have noticed that in the statement for March, we had a sentence that said the committee anticipates that some additional policy firming may be appropriate. That sentence is not in the statement anymore…you will know that the summary of economic projections… this was the ultimate high level of rates. “ – US Federal Reserve Chair Jerome Powell

Figure 1 presents the probability of a potential hike or cut for US rates at the coming meetings, calculated from Fed Funds futures. It indicates that at the next meeting, there is a 30% chance that the FOMC will hike rates. However, it also says that 7 months out, there is an 84% chance the FOMC will rate cuts 2.5 times. If you look at the same data for Europe, the market believes that there is a 95% chance of an ECB rate hike at the next meeting.

This means that the current outlook from central banks around the world is diverse. While corporations are seeing some signs of implied tightening from bank failures, central banks, depending on what part of the world they manage, have very different views from each other. It is difficult to have a convicted opinion, and even if one did, “the market” reaction will be difficult to gauge. For example, is an 80% probability of 2.5% rate cut in January of 2024 positive for equities because we have avoided recession and will start a new economic cycle? Or is it negative because we have formally entered a recession and the FOMC was too aggressive for too long, and needs to cut quickly to try to fix its error? It’s probably truly impossible to tell.

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