The Fed’s Outlook Is an ‘Unrealistic Fantasy’ to Some Investors

In some corners of the market, investors just don’t see how the Federal Reserve can lower inflation without risking high unemployment.

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This article is part of our Daily Business Briefing

By Joe Rennison

At the Federal Reserve’s meeting on Wednesday, alongside warnings of pain to come, policymakers sketched out a hopeful scenario in which they were able to reduce inflation gently, while the economy, albeit weakening, remained resilient.

Not everyone in the market agrees.

In particular, traders and analysts who follow the direction of interest rates closely said that they were bracing for a more dire outcome than the Fed had projected.

“The market thinks the Fed’s economic forecasts are an unrealistic fantasy,” said Mark Cabana, head of U.S. rates strategy at Bank of America.

Interest rate traders have been bruised this year as the Fed’s outlook for inflation and interest rates has repeatedly been upended by reality. The central bank this week raised interest rates by three-quarters of a percentage point — its third such increase since June. The Fed’s policy rate is now the highest it has been since 2008, well above forecasts at the start of the year. And policymakers predict it will move even higher as the central bank escalates its campaign to lower stubbornly high inflation.

After the Fed announced its decision, traders responded swiftly, adjusting prices across an array of interest rate markets like government bonds and futures to reflect the new higher path. But that is where the market’s alignment with the central bank ended.

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The decline of the stock and bond markets this year has been painful, and it remains difficult to predict what is in store for the future.

Instead, market prices are reflecting what many analysts expect to happen. Although the Fed doesn’t forecast lowering interest rates until 2024 at the earliest, analysts are betting that the central bank will have to do so next year. The belief is that the Fed’s aggressive rate increases will tip the American economy into a recession, slashing economic growth and dragging down inflation faster than the central bank predicts. That in turn is likely to force the Fed to shift its focus from fighting inflation and begin cutting interest rates by the end of next year to support an ailing economy.

“The market thinks the economy will slow faster than the Fed does,” Mr. Cabana said. “The market thinks that will slow inflation faster than the Fed does. And the market thinks that will cause the Fed to pivot from tackling inflation to stimulating growth.”

Stocks plummeted on Friday, on course for a second straight week of losses, as investors yanked $4 billion out of funds that buy U.S. shares over a seven-day period ending Wednesday, according to EPFR Global, a data provider.

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