Let’s get ready to move.
The Fed and investors appear to be tied up in what one seasoned market watcher called an epic Game “Chicken”. What Federal Reserve Chairman Jerome Powell says on Wednesday may determine the winner.
Here is the conflict. Fed policymakers have steadfastly insisted that the federal funds rate, now at 4.25% to 4.5%, must rise above 5% and, more importantly, stay there as the central bank tries to bring inflation back to its 2% target. However, Fed Funds futures contracts show that money market traders are not entirely convinced that the rate will go above 5%. And, perhaps most worryingly for Fed officials, traders expect the central bank to make cuts by the end of the year.
Equity market investors also bought into the latest “pivot” policy scenario, which led to a January rally of declines in technology stocks and growth stocks, which are particularly sensitive to interest rates. Treasurys rose, pushing yields down across the curve. Weakness of the US dollar.
Cruisin’ for a bruise?
To some market watchers, investors now look like a lot bigger than their asses. They expect Powell to try and take them down with a peg or two.
How is that? “Look for Powell to be ‘unequivocally hawkish,'” Jose Torres, chief economist at Interactive Brokers, said in a phone interview when he gives a press conference following the conclusion of the Fed’s two-day policy meeting on Wednesday.
“Hawky” is the market language used to describe a central bank that seems hawkish on inflation and less concerned about economic growth.
In Powell’s case, Torres said, that would likely mean asserting that the labor market remains highly unbalanced, calling for significant job cuts that would require monetary policy to remain constrained for an extended period.
If Powell appears hawkish enough, Torres said, in a phone interview, “financial conditions will tighten quickly.” Treasury yields “will go up, technology will go down and the dollar will go up after a message like that.” If not, expect technology and the Treasury to continue to rise and for the dollar to become softer.
hanging loose
In fact, it’s the easing of financial conditions that we see trying to impatient Powell. The more flexible conditions are tighter credit spreads, lower borrowing costs, higher stock prices which contribute to speculative activity and increased risk taking, which helps increase inflation. It also helps in weakening the dollar, Torres said, and contributes to inflation through higher import costs, pointing out that the indicators that measure financial conditions have declined for 14 weeks in a row.
The Federal Reserve Bank of Chicago’s National Financial Conditions Index provides a weekly update on US financial conditions. Positive values have historically been associated with tighter-than-average financial conditions, while negative values have historically been associated with looser-than-average financial conditions.
Federal Reserve Bank of Chicago, fred.stlouisfed.org
To be sure, Powell and the Fed have expressed concerns about the potential for deteriorating financial conditions to undermine their anti-inflationary efforts.
Minutes of the December meeting of the Federal Reserve. Released in early January, it contained this catchy line: “Participants noted that because monetary policy operates importantly through financial markets, unjustified easing in financial conditions, particularly if driven by a public misunderstanding of the Committee’s reaction function, would That complicates the committee’s efforts to restore price stability.”
This was taken by some investors as a sign that the Fed was not eager to see a sustained rally in the stock market, and may be inclined to punish financial markets if conditions softened too much.
Read: The Fed sent a message to the stock market that big hikes will prolong the pain
If this interpretation is correct, then it confirms the idea of it Fed “put” The central bank’s apparent long-standing willingness to respond to a faltering market with an easing of policy is largely half-hearted.
The high-performance Nasdaq Composite posted its fourth straight weekly rise last week, rising 4.3% to end Friday at its highest level since Sept. 14.
advancing 2.5%, its highest settlement since Dec. 2, and the DJIA, the Dow Jones Industrial Average,
rose 1.8%.
Meanwhile, the Federal Reserve is globally expected to deliver a 25 basis point rate hike on Wednesday. This is a downward shift from the series of massive 75, 50 basis point hikes that it delivered over the course of 2022.
We see: Fed set to deliver quarter-point rate hike along with ‘final hawkish sting in the tail’
Data showing inflation in the United States It continues to slow down After peaking at a nearly four-decade high last summer combined with expectations that the economy is much weaker and possibly recession in 2023 has raised bets that the Fed will not be as aggressive as advertised. But Small truck in petrol And Food prices It could trigger a rebound in January’s inflation readings, he said, which would give Powell another baton to beat market expectations for easier policy at future meetings.
Jackson Hole Resurrected
Torres sees the setup heading into this week’s Fed meeting similar to that of Powell’s speech at an annual central banking symposium in Jackson Hole, Wyoming, last August, in which he delivered blunt message Fighting inflation means economic suffering in the future. It spelled doom for what proved to be another of the many bear market highs in 2023, starting the slide that sent stocks to year-lows in October.
But some question how frustrated policymakers are with the current backdrop.
Financial conditions have certainly eased in recent weeks, but they are still tighter than they were a year ago before the Fed embarked on an aggressive tightening campaign, Kelsey Biro, portfolio manager at JP Morgan Asset Management, said in a phone interview.
From a broad perspective, she said, the Fed feels it has become more policy restrictive, as evidenced, for example, by the spike in mortgage rates over the past year.
However, the Fed’s message this week will likely continue to stress that the recent slowdown in inflation is not enough to declare victory and that more increases are in the pipeline, Perot said.
Too soon to bout
For investors and traders, the focus will be on whether Powell continues to stress that the bigger risk is the Fed doing too little on the inflation front or shifts to a message acknowledging the possibility that the Fed could overdo it and sink the economy, Perot said. .
And you’d expect Powell to eventually deliver that message, but this week’s press conference may be too soon. The Fed will not update its so-called dot plot, a set of projections by individual policymakers, or its staff’s economic forecasts until the March meeting.
This could be a disappointment to investors hoping for a showdown this week.
“Unfortunately, this is the kind of meeting that could end up being anticlimactic,” Pirro said.