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The Fed is All Messed Up

The Fed is All Messed Up

March 27, 2023

The Fed raised short-term rates by another 25 basis points (bp) last week and made no changes to the expected peak for short-term rates later this year. That peak is still 5.125%—which is 50 bp higher than they are today—the same forecast they had back in December. The economic forecast from the Fed shows real GDP growing at just 0.4% this year. What stands out about that forecast is that the Atlanta Fed’s GDP Now model currently projects growth at a 3.2% annual rate in the first quarter. The only way you’d get to a 0.4% growth rate for 2023 would be for real GDP to be lower, and eventually negative, in the following three quarters of the year.  

In other words, the Fed is likely now forecasting a recession starting later this year even as it continues to say it will not cut rates later this year. We have a Fed prepared to not reduce rates during the next recession; which would be unprecedented..but that word has become normal over the past 3 years! Although the Fed noted recent problems in the banking system and that these problems might impact the economy and inflation, the Fed went out of its way to end that portion of the statement with language that it ‘remains highly attentive to inflation risks.’ The main emphasis to notice is the importance of inflation risks..not downside risks to the economy.

However, the Fed also opened the door to dovishness if banking problems intensify. We believe the Fed will be in no rush to raise rates at the next meeting and will instead sit back and watch how events in the economy and banking system unfold over the next 6 weeks. The Fed and other ‘authorities’ have, at least temporarily, ring-fenced traditional banks, guaranteeing all deposits in FDIC-insured accounts, no matter how high. This should prevent another bank run, yet at the same time, kick the can down the road for future policymakers to deal with the problem.  

Meanwhile, a new bank term funding program will allow banks access to potentially huge capital injections from the Fed while the banks pay very little fees to the Fed for the service. And yet, while expanding its balance sheet this way, the Fed will simultaneously continue its passive version of ‘Quantitative Tightening’, letting a portion of its balance sheet decline as the securities mature and just roll off. This is like a car with two steering wheels and having the drivers turn them in opposite directions at the same time.

The Fed is all messed up. The reason it’s messed up is that in the 2008—09 crisis, it abandoned its long tradition of implementing monetary policy through scarce reserves and imposed a new policy based on abundant reserves. They didn’t know where it was heading at the time..and now we’re starting to find out.

In short, the turmoil in the markets is not over. We remain cautious about current stock prices and think a recession is on its way. We still believe 15 – 30% of your investment portfolio should be in cash to provide you with peace of mind over the next few months..and then to take advantage of the opportunities that present themselves in 3 – 6 months. We never recommend having more than 30% in cash since all ‘pullbacks’ in the markets throughout history have proven to be, if you’re retired and living off the income from your investments, you just shot yourself in the foot.

If you need to be rescued from yourself or the guy/gal you’re currently working with, we’re here to provide you with a better playbook..just reach out.

Mike Hackler


The views stated in this email are not necessarily the opinion of LPL Financial LLC and should not be construed directly or indirectly as an offer to buy or sell any securities. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed.

Past performance does not guarantee future results. All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful. A diversified portfolio does not assure a profit or protect against loss in a declining market.