- The Fed increased interest rates by 25 bp, to 1-1.25%, while announcing a gradual decrease of its balance sheet, that equates to a very slow tightening of monetary conditions
- The Fed announced that it will keep a close eye on inflation, but didn’t mention the slowdown in consumer spending and other risks
- The markets still pricing in an ‘easier” FED amid the deteriorating economic numbers.
The Federal Reserve is set to reduce its balance sheet after an extraordinary and extended period of loose monetary policy following the financial crisis, at least that’s what the committee announced. Bond markets tell a different story, as yields fell across the board yesterday, while other asset classes are sending mixed signals following the second rate hike of the year.
As the latest inflation and Retail Sales numbers have disappointed analysts, a lot of them have been expecting a slightly more cautious outlook from the central bank. Well, that didn’t happen but long-term yields fell to a seven-month low, as the market smells trouble down the road.
US 10-Year Yield, Daily Chart
The most affected assets should be US Treasuries, the Dollar, gold, together with global stock markets, and sure enough volatility increased in those segments as the market digested the decision. Cryptocurrencies should be negatively affected by the decision, as safe-haven assets, but they have long decoupled from the traditional flight-to-safety segment, as the widespread adoption, new applications, and the growing user base opened up new heights for the coins. That said, the crypto-market followed other asset classes in yesterday volatile trading, but the current technical state of the sector has more to do with the ongoing correction than anything else.
Dollar Index, Daily Chart
The charts say that although the short-term direction of said asset classes might be influenced by yesterday’s decision, the long-term trends are not in line with the optimistic scenarios, and investors (rightfully so) think that central banks will quickly reverse the baby steps that they made to “normalise” their policies.
And as the central banks are very low on ammo—the US base interest rate is still just 1.25%, mind you, with the historical average being around 4%, it will be much harder for them to prop up stock markets and other risk assets next time around. In this environment, hard assets, precious metals, and cryptocurrencies should all do well, while stocks, bonds, and passive strategies will likely lag their historical returns, putting more responsibility into the hands of individual investors.