The Russian assault on Ukraine continues to wreak havoc – both on the people of Ukraine and on financial markets around the world.
With geopolitical tensions escalating, stock markets opened the week in solid red territory. Notable exceptions were oil and other commodity-related names.
Then came word from the White House on Tuesday that the U.S. would indeed refuse Russian oil imports. And we heard that Ukraine was ready to reach a compromise with Russia. Markets rebounded.
But they remain in choppy territory, as these geopolitical events are still unfolding.
Investors are counting on gold as a protector and store of wealth. Gold is up nearly 10% since the start of the year on growing fears of Putin’s intentions towards Ukraine.
Against this backdrop, the Federal Reserve has a critical meeting next week. The decisions it makes will determine whether the markets have a Hail Mary coming to them.
Let me explain what I mean by that.
Fed Bends Under Pressure From Markets
The Fed’s two-day policy meeting, the Federal Open Market Committee (FOMC), takes place on Tuesday and Wednesday next week.
At these meetings, it usually announces any interest rate adjustments it has planned.
I’ve been observing and explaining how the Fed operates for more than three decades – since my years on Wall Street.
And in 2015, I was invited to address global central bankers at the annual Federal Reserve/International Monetary Fund (IMF)/World Bank conference in Washington.
At the time, the Fed had not raised interest rates since the financial crisis of 2008. But it was signposting three to four rate hikes to come.
The other central bankers were afraid of what that could mean for them. At a luncheon that day, Christine Lagarde, head of the IMF, articulated their fears.
In my address, I said I did not think the Fed would raise rates that many times.
In the end, it only raised rates once. I wrote my book Collusion to explain why it backed down.
Naturally, I have some thoughts on what the Fed will do at next week’s meeting. I’ll share those with you today.
And early next week, I’ll explain what the Fed’s decisions could mean for your money.
But first, let’s talk about what the Fed will likely announce next week… and why.
The Fed’s Announcements Will Be Tame
We have already received a very big clue…
After the January FOMC meeting, Fed chair Jerome Powell said that a 50-basis-point rate hike was on the table.
But that was before Russia invaded Ukraine. And it was before the world slapped financial sanctions on Russia’s banks and central bank.
Last Wednesday, Powell made a rare pre-meeting announcement.
In his scheduled semi-annual testimony to Congress on monetary policy, the man behind the money said, “I am inclined to propose and support a 25-basis-point rate hike.”
Powell said the sanctions imposed on Russia and Russian banks in an attempt to stall its invasion of Ukraine could provoke a reshaping of Western economies.
He said the Fed “will proceed carefully as we learn more about the implications of the Ukraine war for the economy.”
The U.S. dollar has risen against other currencies since the financial sanctions were announced in the last couple of weeks.
Investors are scrambling for safety. And the U.S. dollar is seen as a safe haven by foreign investors.
But if the Fed raises rates too much, those dollars will become too expensive for its allies.
That means next week’s FOMC meeting will likely bring an announcement of a 25-basis-point rate hike. I don’t expect anything more than that.
Back in January, long before the Russian invasion of Ukraine, we said that was the most likely scenario. The rest of the market now agrees.
Market consensus sees a 95% probability of a 25-basis-point hike. It sees the probability of a 50-basis-point rate hike as just 5%.
We’ve Seen This Movie Before
We’ve been down this road of the Fed saying one thing and doing another before.
On December 16, 2015, the Fed raised interest rates by 25 basis points (0.25%). And it forecast four rate hikes for 2016.
But the markets freaked out at even the possibility that money would get more expensive. They were fixated on zero percent interest rates.
So the Fed stepped back. We got one rate hike – in December 2016.
And in 2018, when Jerome Powell said interest rate hikes were on “automatic pilot,” the S&P 500 plunged 20%.
The Fed swiftly softened its stance. It decreased rates three times in 2019.
Stock Markets and Cheap Money Go Together
But now, times are different.
The latest U.S. inflation reading was released this morning. It is now at 7.9% – its highest level since January 1982. That gives the Fed a reason to hike rates.
Of course, the situation in Ukraine mitigates that reason. It’s not like the Fed wants war. But war offers it a convenient reason to keep rates low.
And the market will be happy about this. It likes cheap money. There are two main reasons why…
When rates are low, investors look for places to put their money that return more than savings accounts or U.S. Treasury bonds. The stock market is such a place.
Cheap money is to markets what a pacifier is to a baby. That’s the case even when uncertainties abound. Fears of a 50-basis-point rate hike laid the groundwork for recent market volatility. That enabled other events from inflation to Ukraine to compound it. All three major U.S. stock indices are down since the start of the year. The Nasdaq Composite index has dropped 16% since January 3. That puts it squarely in correction territory (a drop of more than 10%) since then. The S&P 500 is down 11%. And the Dow is down 9%.
U.S. markets rallied after Powell’s calming announcement last Wednesday. But they wobbled on reports of intensifying violence in Ukraine to close the week. They opened this week down and then rebounded, as I mentioned above.
Amid such volatility, the Fed won’t want to shock the markets with more than a 25-basis-point hike right now.
And the possibility of a 50-basis-point hike is remote in the current environment.
There is even a slight chance the Fed won’t hike rates at all. It depends how bad things get in Ukraine.
I’ll explore these scenarios further in the second part of this essay next week.
This discussion will set up our expectation for what will happen in the markets after the March FOMC meeting.
Uncertainty Can Create Opportunity
But for now, you can rest assured that, no matter what the Fed announces next week, the stock market will eventually resume its upward climb.
That’s because of the permanent distortion between the markets and the real economy I’ve been telling you about. As long as money remains relatively cheap, markets will continue to inhale it. And that will elevate prices.
But there will be volatility to contend with along the way.
The ongoing situation in Ukraine, rising inflation, and uncertainty around the Fed’s plans guarantee that.
I see this period of Fed policy uncertainty as a strategic buying opportunity in the midst of other global turbulence.
Next week, I’ll give you a strategy to protect and grow your wealth in these uncertain times. So look out for that in your inbox early next week.
Happy investing, and I’ll be in touch again soon.
Editor, Inside Wall Street with Nomi Prins
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