Market participants' expectations can be very shaky, as confirmed after the Federal Reserve's latest meeting ended. What information made things so much worse?
The expectations of market participants in financial markets are indeed shaky when information comes to light that was not so much anticipated before.
Of course, the form in which this information is presented also matters. The last Federal Reserve meeting was not so much a turning point in principle, but information was presented that significantly dampened previous optimism.
The monetary policy decision of the US central bank included an economic projection with the key outlook of each central banker for the coming years.
As already mentioned, this was not really anything new. The Fed cut the key interest rate by the expected 0.25 percentage point and the projection was not ground breaking at first glance.
However, the subsequent press conference with Chairman Jerome Powell caused more sobering news.
It was the worst trading day of the year for the overall stock market. We did see slightly deeper declines in August, but this time the net loss for the trading day was more than 3%.
Once similar panic selloffs occur, they normally continue for some time before the market drops to a point where it can gain a foothold.
Why did stock markets face the biggest drop of the year?
To understand the whole situation, we first need to look at the economic projection for the period ahead. First of all, I want to focus on 2025, which is logically the key year.
I will not beat around the bush and we will focus on the most important things: The projection indicates a much higher level of interest rates for 2025.
Since the September projection, the median level has risen from 3.4% to 3.9%. The Fed is also counting on much higher headline and core inflation next year, which is well above the inflation target on the whole.
The estimate for core inflation is 2.5%, up from 2.2%. Headline inflation is also projected to be 2.5% in 2025, up from 2.1%. Recall that inflation targeting is at 2%. Both estimates are therefore 50% above target.
The derivatives market immediately started to write the above, according to which the next cut in rates should come in June. Incidentally, the derivatives market is now prescribing only two cuts for next year. So just copying what the Fed has in its outlook.
However, the above had no effect on the financial markets. There will always be some volatility, but there will not immediately be a drop of more than 3% in the overall market.
So what exactly sent stocks and bitcoin down?
Jerome Powell mentioned during the press conference that rates will go down much more slowly next year. First of all, he acknowledged that the core component of inflation has been going sideways for a long time.
Core inflation in the CPI and PCE have been virtually unmoving for months, which represents so-called stickiness.
This is quite a complicating development for central bankers as they have to balance between the labour market and the price level (dual mandate).
This means micromanaging, trying to find a level of restriction that will secure the 2% inflation target in the long run without hurting the real economy.
In addition, he mentioned that inflation risk has risen. This particular piece of information is, in my view, the key source of concern that triggered the sell-off. It's as if he started shouting that interest rates quite possibly won't fall at all in 2025.
The financial markets, or equities, $BTC , gold, everywhere were counting on base rates falling noticeably below 4% in 2025.
Incidentally, the bitcoin canary initially wrote off just over 6% for Wednesday's trading day. The market therefore held up nicely compared to the overall market.
Only the decline continued and as of Friday afternoon, bitcoin has written off 13% from the high. It's still a price decline within the confines of a correction, but there is clearly a minor panic.
Conclusion
When one invests, one must think twice about why and what one puts the money earned into. And the worst thing ever is when someone carelessly squanders borrowed money.
But I hope there are no such people among my readers, because sooner or later hell will be yours.
Anyway, you have to keep your expectations within certain rational boundaries.
Once "everyone" is chiming in with a higher estimate for the price of bitcoin or for a stock index, no one should be surprised that these predictions don't come true. At least not in the short term.
Markets should be thought of as a complicated organism that is influenced in real time by a theoretically infinite number of variables.
It is therefore impossible to predict exactly how the market will evolve. However, some analysis is still better than investing on the advice of friends at work.
