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The Fact The Fed Changed Its Reaction Function Is Driving Markets

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The Fed Doubled Down on being Dovish – Helping Stocks Rise

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The Fed was dovish up to the June meeting.

The Fed was dovish at the June meeting.

In the week leading up to Chairman Powell’s testimony in D.C. we had some good data (like the strong non-farm payrolls data) that had some people concerned the Fed would back down on their dovishness.

They didn’t.&nbsp; Chairman Powell calmly address the politicians and re-iterated his commitment to drive inflation higher.

A lot of people are discussing how many rate cuts there will be?

What will the size of the rate cuts be?

I don’t think that matters at all. What matters is that the Fed’s &quot;Reaction Function&quot; has changed.

  • The Fed will be slow to tighten on signs of economic strength or inflation
  • The fed will be fast to ease on signs of economic weakness or deflation.

This new reaction function is supportive for equities.&nbsp; It doesn’t mean that equities won’t go down again, but it is supportive and must be fully taken into account by the market.&nbsp; I don’t think that has occurred yet.

It is unclear why the Fed has made such a U-turn in direction since December.

It could be as simple as the Fed painted themselves into a corner and felt compelled to stick to their new dovishness?

Maybe they have tweaked their models and realized they had rates set too high?

Maybe they all finally drank the inflation is good Kool-Aid?

Maybe, and this would be a lot more encouraging, they wanted to take pressure off the economy and markets so that the administration could play hard ball with China and&nbsp; not worry as much about the short-term economic impacts as the Fed’s easy money stance mitigates that risk to some degree.

If it is the latter reason, I’d be impressed and encouraged since I think it makes sense for the country and the economy in the longer run.&nbsp; I also think it would be a good reason to see this current strength last longer than it would otherwise.

In any case, it also confirms that it is far easier to say you want to kill the Fed Put than to actually kill it, since there are for more incentives for Fed chairs to be dovish than hawkish!

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The Fed Doubled Down on being Dovish – Helping Stocks Rise

Getty

The Fed was dovish up to the June meeting.

The Fed was dovish at the June meeting.

In the week leading up to Chairman Powell’s testimony in D.C. we had some good data (like the strong non-farm payrolls data) that had some people concerned the Fed would back down on their dovishness.

They didn’t.  Chairman Powell calmly address the politicians and re-iterated his commitment to drive inflation higher.

A lot of people are discussing how many rate cuts there will be?

What will the size of the rate cuts be?

I don’t think that matters at all. What matters is that the Fed’s “Reaction Function” has changed.

  • The Fed will be slow to tighten on signs of economic strength or inflation
  • The fed will be fast to ease on signs of economic weakness or deflation.

This new reaction function is supportive for equities.  It doesn’t mean that equities won’t go down again, but it is supportive and must be fully taken into account by the market.  I don’t think that has occurred yet.

It is unclear why the Fed has made such a U-turn in direction since December.

It could be as simple as the Fed painted themselves into a corner and felt compelled to stick to their new dovishness?

Maybe they have tweaked their models and realized they had rates set too high?

Maybe they all finally drank the inflation is good Kool-Aid?

Maybe, and this would be a lot more encouraging, they wanted to take pressure off the economy and markets so that the administration could play hard ball with China and  not worry as much about the short-term economic impacts as the Fed’s easy money stance mitigates that risk to some degree.

If it is the latter reason, I’d be impressed and encouraged since I think it makes sense for the country and the economy in the longer run.  I also think it would be a good reason to see this current strength last longer than it would otherwise.

In any case, it also confirms that it is far easier to say you want to kill the Fed Put than to actually kill it, since there are for more incentives for Fed chairs to be dovish than hawkish!

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