Which monetary path will the Fed take?

Amid the ongoing crisis in Russia and Ukraine, the Dow posted its biggest one-day gain since November 2020, in part because investors see a more dovish Fed policy ahead, similar to what happened in 2001. It is worth noting, however, that us inflation is much more severe now than it was more than two decades ago. Some analysts believe uncertainty will continue to roil the market.

On Friday, the Dow Jones Industrial Average rose 834.92 points, or 2.5%, to 34058.75. It was the Dow's best day since November 2020. The STANDARD & Poor's 500 index rose 95.95 points, or 2.2%, to 4384.65. The Nasdaq Composite index rose 221.04 points, or 1.6%, to 13,694.62.

Some analysts and investors said the rally late last week had more to do with expectations that the Fed would be less aggressive in raising interest rates. Some officials said they thought the conflict had added so much uncertainty to the economic situation that a March rate hike of 0.25% was more likely than the 0.50% rate some officials had suggested.

"I don't think the period of high volatility is over," says Daniel Egger, chief investment officer of St. Gotthard Fund Management. "Now we must pay attention to the follow-up of the Russia-Ukraine incident."

"Ultimately, the long-term trajectory of risk assets is largely unchanged," said Seema Shah, chief strategist at Principal Global Investors. "But that path is likely to be subject to significant volatility and uncertainty."

So far, the market reaction to the geopolitical events has been muted. Most sectors of the U.S. stock market rose last week. Technology stocks have played a big role in the market's twists and turns in recent sessions.

Utilities, health care and real estate all rose more than 2 percent for the week, while manufacturers and materials stocks edged higher. Consumer staples, consumer discretionary and financial companies all fell slightly on the week, despite gains on Friday.
No one can explain geopolitical contingencies. At its August 2001 meeting, the Federal Open Market Committee hinted that it might start raising interest rates "relatively soon". After 9/11, however, the Fed cut rates by 1.5 percentage points in less than two months.

In other words, investors who have overhauled their portfolios based on what the Fed might do could be in trouble if it does something completely different.

In recent months, many professional investors have realigned their positions to try to profit from what they see as an imminent opportunity for the Fed to raise rates. But if there is another shift in Fed policy, some bond funds that are betting so aggressively will end up reporting poor results.

But again, the context of today's geopolitical events is very different from 2001. During that period, US inflation was still relatively tame, with CPI growth running at around 2.7% year-on-year, while the latest CPI data had risen to 7.5%.

'During periods of geopolitical turmoil over the past half century, global stock markets have tended to move in sync,' says Elroy Dimson, a finance professor at Cambridge University's Judge Business School. To put it bluntly, when conditions worsen, almost all markets fall at once, which can make diversification seem useless.