A Look Ahead at 2023

The Fed will continue to raise overnight interest rates at its February 1 meeting and likely at its March 22 meeting, as well.  However, it will likely only be a rate increase of 0.25% as opposed to the 0.5% rate hike in December.  That will bring the overnight interest rate to 4.5%

Raising the overnight interest rate is never good for the stock and bond markets because it can push up long term interest rates, which are very important to the markets.  Strangely though, in the last two months, just the opposite has happened, which has been a big source of support for both markets. 

Oddly, the Rate on the 10-year Treasury Bond Has Dropped While the Overnight Interest Rate Increased

Even though the Fed increased the overnight interest rates by 0.75% in November and 0.5% in December, the interest rate on the 10-year Treasury bond DECREASED almost 1%.

That’s crazy.  In fact, it’s close to insane.  The overnight rate doesn’t have to affect the 10-year rate, but it usually does.  Especially so when the Fed is selling off its bond portfolio, which puts upward pressure on the interest rate for 10-year bonds. 

The amount of bonds that the Fed is selling now is big.  Last March, the Fed was BUYING $100 billion in bonds per month.  Now it is SELLING $100 billion in bonds per month.  That’s a $200 billion/month net reduction in Fed bond purchases.  Typically, a significant reduction in bond purchases by the Fed would increase the interest rate for bonds.  

But, at least recently, it has not. 

Also, part of the reason investors are buying bonds now is they hope that long-term rates will go down over the rest of the year.  If so, they would get some capital gains.

A Bullish Change Is Underway and Could Grow Stronger in February

As we have often said before, the market strongly believes that up is good and down is bad.  Given that mentality, the market reacted to recent inflation figures, which showed inflation continuing to slow, quite positively.  So much so that the news will encourage the Fed to only increase the overnight interest rate by 0.25% instead of 0.5% on February 1. 

We agree.

The bullish outlook could get even stronger if the Fed actually does increase rates by only 0.25% on February 1 which would indicate the Fed may pause its rate increases after another 0.25% at the March 22 meeting. That doesn’t mean a decrease in rates is coming, but even stopping the increases will further encourage bullish sentiment. 

The big short-term risk to such a rally is that the 10-year rate is still under pressure to go up due to the Fed selling its bonds.  However, it could be a while before we see that pressure turn into a significant rise in the 10-year bond rate.  The bond market has certainly ignored Fed bond selling more recently. 

 The Short-Term Risk of Rising 10-Year Rates Will Fade Over Time

The short term risk of 10 year rates rising will continue as long as the Fed is selling bonds or even just not buying bonds.  Currently, there is ravenous demand for 10 year and other longer term bonds among private investors which is keeping long term rates down.  However, if for some reason, that demand drops, there is a risk of long-term interest rates rising, which would hurt the market.

This could happen anytime in the next 3 to 9 months.  But, over the same period, bullish sentiment will be growing stronger in an effort to offset the past year’s losses.  That bullish sentiment could overcome much of the downward pressure from rising rates.  Also, in the longer term, interest rates can’t rise too much because the Fed will eventually stop selling and start buying bonds. 

In fact, the Fed has NO CHOICE but to quit selling bonds and eventually return to buying bonds to support the enormous ongoing government borrowing forced by the enormous federal deficit.  Our deficit is much larger now than in the recent past (2010 to 2020) and is likely to continue to grow for at least the next 10 years, according to the Congressional Budget Office.

When the Fed returns to buying bonds instead of selling them, both the bond and the stock will rejoice.  Again, this will not be a choice for the Fed.  With deficits so large and long term, they will be forced to start buying bonds again.

Also, the Fed will likely need to lower mortgage rates by buying mortgage bonds (which are just another long term bond) later this year or the housing market could see real price declines and continue to be a drag of the economy.

It’s Been a Long Stock Market Downturn – Is This the Aftershock?

After almost a year of bad news for the stock market, and more likely to come, it is very reasonable to wonder if the market will rebound, as we predict, or if maybe this is actually the beginning of the Aftershock and the market won’t rebound.

As the authors of Aftershock, we have a lot to say about that.  However, we will keep the answer simple: This is not the Aftershock.  We have not yet met any of the three criteria necessary for the Aftershock.  Before we hit the Aftershock, we need to meet ALL three of the conditions below:

1.    Inflation, as measured by the CPI, is over 10% and rising

2.    The Fed is massively printing money

3.    Interest rates are rising despite the Fed’s massive money printing

When these three conditions occur, the Fed will have essentially lost control of interest rates.  Until the Fed loses control, there will be no Aftershock.

 Will a Recession and Debt Ceiling Standoff be Big Problems for the Stock Market?

We don’t think a recession will be that severe and the debt ceiling standoff will be short term.  But they are both clearly problems.  More on those issues in the second half of our Look Ahead at 2023.