This past week we have seen U.S. equity markets edge up to new highs. The stock market’s performance has continued to impress us since March. In our view, this performance can be attributed to continued positive earnings, upbeat expectations for growth over the next 18 months and a pullback in interest rates following the historic rise that began late last summer. The pullback in rates indicate that the dire predictions for rampant inflation may have been a bit overdone.
All this suggests the possibility of worldwide stock and bond markets settling into what is referred to as a “Goldilocks Scenario,” where growth is strong, yet inflation is measured, thereby giving the Federal Reserve room to remain dovish and not raise short term rates. Long term rates are determined by the market and may continue to rise at a quicker pace if investors demand more yield in return for tying up their money in bonds and forgoing other investment opportunities. This stage of the economic cycle is deemed by many market observers to be “just right” (not too hot and not too cold). We have discussed this concept in years past and it is worth noting that it is seen as a great time to be a diversified investor. Unfortunately, these conditions usually don’t last very long as something inevitably gets too hot or too cold.
It is with this backdrop in mind that all eyes have been on the Federal Reserve and the minutes coming out of their meeting, which concluded yesterday afternoon. Everyone wants to know how the all-important central bank is interpreting the reams of data coming in on employment, consumer prices, housing and manufacturing. The big question is always whether the Fed is going to change course and do something to upset the apple cart…. like changing accommodative monetary policy and raising rates faster than expected. Stock investors like growth and low rates. Rarely do we get both in a sustained fashion.
So, what was the verdict that came out yesterday? The Federal Reserve acknowledged growth and vastly improved economic conditions across the board. They also acknowledged that this expansive growth might cause them to hike rates… sometime before the end of 2023! Two years or more from where we stand today. They otherwise left rates at 0-25bps. That sounds pretty good to me and a whole lot like a “Goldilocks Scenario”. Of course, I am just one person and do not claim to be omnipotent. The rest of the market took any change in the forecast as a negative and both stocks and bonds immediately sold off. The knee jerk reaction abated after an hour or so and markets of all types recouped some of the losses before market close. We will watch how this new perspective plays out over the next few days as we close out the second quarter.