The Fed Will Set the Pace for Markets More Than Ever This Year

The surge in consumer prices that drove inflation way past central banker’s targets in recent years triggered a wave of interest-rate hikes. But as policymakers were desperate to rebuild their credibility as overseers of monetary stability, their zeal threatened to savage growth and spark unemployment. The pause in hiking we’ve seen in recent months is now expected to be followed by an easing of policy.

As the charts below argue, what the Federal Reserve does next will be more important than ever in determining how financial markets behave in the new year.

Don’t Fight the Fed

This truism should become the obligatory screensaver of every trader and portfolio manager. After 11 interest-rate hikes and 525 basis points of tightening, the market senses the tide is turning. Exactly when the US central bank decides to ease is perhaps less important than the speed and scale of the easing cycle — and futures traders are anticipating rapid and deep cuts.

Rate Cuts on the Horizon

When it comes, the first Fed reduction is likely to be a substantial 50 basis points, and that scale of move could repeat until officials feel monetary policy is no longer restrictive and more in tune with calmer inflation.

The prospective easing cycle is likely to be both quicker and shorter than the last two years of ever-higher borrowing costs. Futures markets badly underestimated the US central bank’s resolve to curb consumer price increases in 2023. Garnering a clearer picture of where official interest rates level out is the big trade for fixed-income markets this year, and will determine the shape of the (currently still inverted) yield curve. In the meantime, most of the world’s central banks are locked in the Fed’s tractor beam — where it leads, others will have to follow.