Sensitive
US equities surged on Wednesday following the Federal Reserve's decision to keep rates steady, as anticipated, while signaling two more rate cuts later this year.
The S&P 500 rose by 1.1%, the Dow Jones gained 384 points, and the Nasdaq 100 led with a 1.4% jump.
Tech stocks held their morning gains as volatility subsided, with Nvidia (up 1.8%), Broadcom (up 3.7%), and Alphabet (up 2.2%) posting solid gains.
Tesla also rose by 4.7% after securing $1 billion in equity funding.
The Fed’s decision to slow its balance sheet reduction further boosted market sentiment, enhancing liquidity.
We heard from the Fed;
They held rates steady at 4.25%-4.5%.
Stocks went up. Yields went down. The dollar went down.
But if we look at the Fed's updated projections, they revised growth DOWN and inflation UP.
And while the "median" projection for rate cuts by year-end was unchanged at 50 basis points, the weighted-average target from the 19 Fed officials came in 17 basis points higher than the last time they did this exercise, back in December.
So, in this summary of economic projections, the Fed sees a worse economy, higher inflation and fewer rate cuts than in December.
None of that warrants the market reaction we had. But the Fed did something else.
Beginning next month, they will sharply slow the pace that they have been shrinking the balance sheet – from $25 billion a month, to $5 billion a month.
Why? As Jerome Powell said in his press conference, "We have seen some signs of increased tightness in money markets."
That sounds familiar. Remember, back in 2019, the Fed spent eighteen months shrinking the balance sheet, draining liquidity from the financial system, and they created a cash crunch (a scramble for dollars in the interbank lending market). This happened ...
The Fed described this chart above as "strains in money markets that occurred against a backdrop of a declining level of reserves, due to the Fed's balance sheet normalisation and heavy issuance of Treasury securities."
What does that mean?
The pendulum swung from too much liquidity, to too little liquidity.
This was the Fed's unforeseen consequence of balance sheet "normalisation." They were forced to put it all in reverse, to pump liquidity back into the financial system, and at a record rate (i.e. it was a return to QE).
With that, clearly Jerome Powell is highly sensitive to signs of stress in money markets.
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