If you’re out hiking, and you step too close to the edge of the cliff - does it matter if you know it or not?
Apparently it does. Several behavioral researchers found that if you’re aware of the danger, fear itself may cause you to lose your balance and fall. But does it necessarily mean you’re better off remaining unaware of what’s coming?
The Fed hiked the rates once again this week, and declared that “The U.S. banking system is sound and resilient”. But does it have any other choice? Inflation is still far off from the 2% mandate, and stating anything else about the banking system is clearly irresponsible. Is it possible we’re at the edge of the cliff but don’t know it yet?
One indication that something’s off is in the graph below:
It seems the market doesn't believe the Fed, so much so that the difference between the Fed funds futures curve and the Fed funds rate projection is over 100 bps. That’s unheard of. The market is unsure whether the financial system can stand the continued Fed rate hikes, and predicts that instead of going up - the rates will come back down.
When inflation grows unmonitored, the outcome can make it worse for everyone. Those of you out there who have come across hyper-inflation during their lifetime, know exactly what’s the worst case scenario. Since the Fed is in charge of bringing the inflation down, hiking the rates becomes almost mandatory. But the Fed needs a sound and resilient financial system to complete the cycle.
Stating that the banking system is sound and resilient turns it to sound and resilient. It confirms trust and eliminates any fear of liquidity issues. It proves to the market that there’s someone at the wheel, and that everything is going to be alright (made you look :).
Either way, the recent Fed hike (and the already anticipated next one, mind you), is meant to shape the economy and stir it in the right direction. We need to keep that in mind when looking at these graphs. It’s not a lot, but it's hopeful. Sometimes all you need is to hear someone say they’re going to weather through the storm with you - just enough so you can get back down from the edge of the cliff.