What happens to markets and the economy when the Federal reserve raises rates? This has dominated all financial news for most of the last two years. Of course, in the real world where everything is interconnected, if-then statements are utterly useless.
Wilbur Wright, in McCullough’s fantastic The Wright Brothers, nails this concept when talking about the difficulties of designing a propellor.
“But on further consideration [Orville would explain], it is hard to find even a point from which to make a start; for nothing about a propeller, or the medium in which it acts, stands still for a moment. The thrust depends upon the speed and the angle at which the blade strikes the air; the angle at which the blade strikes the air depends on the speed at which the propeller is turning, the speed the machine is traveling forward, and the speed at which the air is slipping backward; the slip of the air backwards depends on the thrust exerted by the propeller, and the amount of air acted upon. When any one of these change, it changes all the rest, as they are all interdependent on one another.”
So what happens to markets when the Fed raises rates? That depends on a few things:
Where are rates coming from? Are they average, above average or below average. And how far above or below? What does the yield curve look like? What about the dollar? How expensive are stocks? And what do you mean by expensive. Are we talking price/earnings? Price/sales? Enterprise value/EBITDA? And what does inflation look like? What about sentiment? What about earnings? What about GDP? What about productivity? What about employment? What about housing?….
Markets are so interesting and exciting because things are constantly changing. The minute we think we have something all figured out, we become the raccoon in the video….