Market Review Q123: Reading the Monetary Tea Leaves

The strong first quarter for the S&P 500 belied a lot of thrills and spills for other parts of the market. Banks were ground zero for most of the problems, but stress also radiated out through rates and currency and many less visible asset markets.

One of the clear messages for investors is that policy responses matter. The S&P 500 bottomed shortly after Silicon Valley Bank failed, but then quickly rebounded. The lesson being: In this age of activist central banks, the best assumption is somebody will do something when something breaks. As a result, gauging potential policy reactions is every bit as important as analyzing fundamentals.

What is the Fed doing?
Of course, this activist tendency of central bankers emerged long ago. After great strides were taken to stanch the market decline during the GFC, the Fed took a liking to its newfound freedoms and maintained extra-easy monetary policy for another twelve years. In doing so, it fundamentally transformed its role from monetary supervisor to financial asset facilitator.

More recently (just a year and a half ago), the ten-year Treasury yield was only a little over 1% while inflation was breaking solidly into mid-single digits. Later in the fall, almost overnight, the Fed’s role flipped from facilitator to inflation fighter.

The transformation caused a great deal of consternation, and rightly so. It’s hard enough for investors to get the economic fundamentals right. It’s far harder to nail both the fundamentals and the Fed’s sometimes cockamamie policy response to them.