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In truth, not much happened on the news front this week. The housing data did come in better than expected, which was good news and supports the idea that a recession is still some ways away. But, as we discussed last week, we kind of knew that already. Fed Chair Powell testified that the central bank is still determined to get inflation down to the 2 percent target and that it plans to keep rates high—and maybe raise them further. Again, we knew that because he has been saying it over and over for more than a year now. This week was more about olds than news.
But there is one thing that is worth taking a look at: the market reaction to Powell’s testimony. The market dropped and has since continued to decline. If this wasn’t news, then why the market reaction? That is worth some discussion.
Groundhog Day All Over Again?
What we have seen again and again during the past several months is that the Fed will commit to getting inflation under control through higher rates, and then the market will drop as a result—just as we are seeing now. But then, over the next couple of weeks, the market will somehow become convinced that rates are really coming down after all—and will rally until Powell or another Fed member comes out and recommits to higher rates again. And it is Groundhog Day all over again.
What Are the Markets Telling Us?
There are two things that matter here. First, the Fed remains committed to keeping rates high until inflation subsides. Keep that in mind and ignore the speculation and the headlines. Second, even given that and the periodic setbacks, the financial markets have shown surprising strength. Longer-term interest rates have remained constrained, and the trend of the stock market has been higher since about last October.
What the financial markets are telling us, backed by the other data, is that the Fed is pulling off what no one really expected: a soft economic landing even as inflation continues to decline. If you believe markets are rational, this is really good news. Even the periodic pullbacks, as we are experiencing now, are signs of that rationality, as investors respond to current events. This is what we are seeing, and should be seeing, in a healthy economic and market environment.
Look Beyond the Headlines
That is what mattered this week. Not much on the news front, but the markets are functioning as they should. For that reason, we can believe that the outlook is a lot better than the headlines continue to suggest. And that is a good way to end the week.
Have a great weekend!
