Fed is no longer in the driver's seat

@THEMARKET

This week, the Federal Reserve Bank hiked its inflation forecast and reduced the growth target for the economy this year. Despite this news, traders termed the March Federal Open Market Committee meeting a "dovish pause," although it did not help the stock market.

The upshot of Chair-man Jerome Powell's Q&A session on Wednesday afternoon after the meeting was that, as far as the future is concerned, the Fed would need to wait and see just like the rest of us. In the meantime, the bank decided to slow its quantitative tightening program. That was interpreted as dovish by most Fed watchers since it does add liquidity to the credit markets.

Powell did say that tariffs would probably add to the inflation rate (from 2.5 percent now to 2.8 percent). Although for the most part, he believed these measures would be "transitory." The rate of economic growth would also fall from 2.8 percent in 2024 to 1.7 percent this year.

Those forecasts, while not what I would call a full-fledged period of stagflation like we experienced in the 1970s, are akin to my own expectations. I would call it a brief bout of stagflation but with a small "s." I see a quarter or two of slower growth and a smidge higher inflation rate, but I do not see these trends remaining in place for the full year.

"I don't know anyone who has a lot of confidence in their forecast," Powell conceded, but the median of Fed officials still expect two rate cuts this year. However, their conviction on where things are heading is weak, and understandably so. After many years in the driver's seat, the Fed is now in the back seat as far as the economy is concerned.

Fiscal policy as interpreted by President Donald Trump is now calling the shots. Depending on how badly the coming tariff war develops, the administration's overall trade policy, spending cutbacks, immigration restrictions and deregulation, we could see a recession.

However, if tariffs turn out to be simply a negotiating tactic, as many expect, tax cuts do get passed, and somehow the deficit falls then growth could resume, inflation remains in check, and the markets could live happily ever after. I give 50/50 odds on these economic outcomes.

I hate "on the other hand" statements, but sometimes, they are what they are. Whether your cup is half full or half empty, I suspect, depends on your political persuasion. As Powell said, "I mean, it's really hard to know how this is going to work out." My sentiments exactly.

Unfortunately, the financial markets do not do well when faced with the unknown. As such, the present turmoil in the markets should continue. About the best I can say is that we should expect the daily 1 to 2 percent swings in the equity market to slow down a bit after this week after Friday's multitrillion-dollar options expirations. That does not mean the downside is over. The fate of the markets remains dependent on the news coming out of the White House.

Behind the scenes, the top men at Treasury and Commerce and Trump's economic adviser, Kevin Hassett, are working hard to reduce the impact of the coming tariffs before the deadline. Scott Bessent, the U.S. Treasury Secretary, appears optimistic they can work a deal between the U.S. and our largest trading partners to roll back tariffs before the April 2 deadline. If so, that would go a long way to alleviate the downside pressure on the markets.

At its low, the S&P 500 Index has been off by a little more than 10 percent. Since then, we have bounced, as I expected, but we could still retest those lows or even break them.

Sentiment among market participants couldn't be worse. That makes me suspect there might be some light at the end of the tunnel. Of course, I could be wrong and that light at the end of the tunnel could be a freight train. Let's see what happens.

Bill Schmick is registered as an investment adviser representative of Onota Partners Inc. in the Berkshires. He can be reached at 413-347-2401, or email him at [email protected].