The Fed and the stock market are expected to face off this week. What is at stake.
Let’s get ready to rumble.
The Federal Reserve and investors appear to be locked in what one seasoned market watcher has described as an epic game of “chicken.” What Fed Chairman Jerome Powell said on Wednesday could determine the winner.
Equity investors also bought into this latest policy “pivot” scenario, fueling a January surge in battered tech and growth stocks, which are particularly interest rate sensitive. Treasuries rallied, driving yields lower across the curve. And the US dollar has weakened.
Cruising ‘for a bruise’?
To some market watchers, investors now seem way too big for their pants. They expect Powell to try to knock them down a pawn or two.
How? Look for Powell to be “unambiguously hawkish” when he holds a news conference following the conclusion of the Fed’s two-day policy meeting on Wednesday, Jose Torres, senior economist at Interactive Brokers, said in a phone interview.
“Hawkish” is market jargon used to describe a central banker who seems tough on inflation and less concerned about economic growth.
In Powell’s case, that would likely point to the labor market remaining significantly unbalanced, calling for a significant reduction in job vacancies that will keep monetary policy tight for a long time, Torres said.
If Powell appears hawkish enough, “financial conditions will tighten quickly,” Torres said in a phone interview. Treasury yields “would rise, technology would fall, and the dollar would rise after a message like that.” If not, expect the Tech and Treasury rally to continue and the Dollar to weaken.
Indeed, it was an easing of financial conditions that tested Powell’s patience. Softer conditions are represented by tighter credit spreads, lower borrowing costs and higher stock prices which contribute to speculative activity and increased risk taking, which helps fuel inflation . It’s also helping to weaken the dollar, contributing to inflation through higher import costs, Torres said, noting that indices measuring financial conditions have fallen for 14 straight weeks.
Powell and the Fed have certainly expressed concerns that loose financial conditions could undermine their inflation-fighting efforts.
Minutes from the Fed’s December meeting. published in early January, contained this eye-catching line: “Participants noted that because monetary policy operates importantly through financial markets, an unwarranted easing of financial conditions, especially if motivated by a misperception by public of the Committee’s reaction function, would complicate the Committee’s effort to restore price stability.
This was interpreted by some investors as a sign that the Fed was not eager for a sustained stock market rally and might even be inclined to punish financial markets if conditions loosen too much.
Read: The Fed has sent a message to the stock market: Big rallies will prolong the pain
If this interpretation is correct, it underscores the idea that the Fed’s “put”—the central bank’s seemingly longstanding willingness to respond to a plummeting market with policy easing—is largely kaput.
The tech-heavy Nasdaq Composite posted its fourth straight weekly gain last week, rising 4.3% to end Friday at its highest level since Sept. 14. The S&P 500 SPX,
advanced 2.5% to record its highest settlement since Dec. 2, and the Dow Jones Industrial Average DJIA,
increased by 1.8%.
Meanwhile, the Fed is almost universally expected to deliver a 25 basis point rate hike on Wednesday. This is a pullback from the series of outsized 75 and 50 basis point increases it has achieved during 2022.
To see: Fed set to hike rates by a quarter point with ‘one last hawk bite in the tail’
Data showing that US inflation continues to slow after peaking at a roughly four-decade high last summer, alongside expectations of a much weaker and potentially recessionary economy in 2023, has fueled bets that the Fed will not be as aggressive as announced. But a recovery in gasoline and food prices could send January inflation numbers bouncing back, he said, giving Powell another punch to fend off market expectations in favor. an easier policy at future meetings.
Jackson Hole Redux
Torres sees the setup ahead of this week’s Fed meeting as similar to preparing for Powell’s speech at an annual central bank symposium in Jackson Hole, Wyoming, last August, in which he said. delivered a direct message that fighting inflation meant economic pain ahead. That spelled the end of what turned out to be another of 2023’s many bear market rallies, triggering a fall that took stocks to their lowest for the year in October.
But some wonder how frustrated policymakers really are with the current environment.
Sure, financial conditions have eased in recent weeks, but they remain much tighter than they were a year ago before the Fed embarked on its aggressive tightening campaign, Kelsey Berro said, portfolio manager at JP Morgan Asset Management, in a telephone interview.
“So from a holistic perspective, the Fed feels its policy is getting more restrictive,” she said, as evidenced, for example, by the significant rise in mortgage rates over the year. elapsed.
Still, the Fed’s message this week is likely to continue to stress that the recent slowdown in inflation is not enough to declare victory and that further hikes are on the way, Berro said.
Too early for a change
For investors and traders, the focus will be on whether Powell continues to stress that the biggest risk is that the Fed does too little on the inflation front or shifts to a message acknowledging the possibility that the Fed could overdo it and sink the economy, Berro said. .
She expects Powell to deliver that message eventually, but this week’s press conference is probably too soon. The Fed won’t update the so-called dot chart, a compilation of forecasts from individual policymakers, or its staff’s economic forecasts until its March meeting.
This could prove disappointing for investors hoping for a decisive showdown this week.
“Unfortunately, this is the kind of meeting that could end up being disappointing,” Berro said.
[gpt The Fed and the stock market are expected to face off this week. What is at stake.