Financial markets suffered an absolute bloodbath in the days leading up to Wednesday’s Federal Reserve decision, as stocks plummeted and bond yields soared on surprisingly hot inflation data – a sign investors were expecting a more Volcker-like reaction from the chairman Fed Jerome Powell and the rest of the Federal Open Market Committee feared.
But now that the dust has settled, it looks like Powell can’t help but be himself — and stocks and bonds thanked him for it after the Fed hiked interest rates by 75 basis points, the largest such move since 1994 .
After a muted initial reaction that saw the US Treasury yield curve briefly invert, bond, stock and even cryptocurrency prices rallied as Powell left enough leeway for the amount of hike investors can expect at the July meeting , as Powell said could go by 75 basis points or 50 basis points – and that the Fed would remain data dependent as always.
“I think we came to that meeting people were really fearing the worst, that not only were we going to get the 75 basis points, but he was going to talk very sharply,” said Kenneth G. Tropin, founder and chairman of Graham Capital Management , a macro hedge fund that has $18 billion under management. “In the end he didn’t do that, he wisely gave himself an option.”
Rather than shocking markets with a more aggressive tone, Powell was “more diplomatic, measured. But he is,” added Tropin.
Ultimately, it looks like the market may have been overwhelmed during the recent sell-off as investors braced for Wednesday’s 75 basis point hike, expectations shattered by a report in Monday’s Wall Street Journal that indicated the oversized movement was seemed to be cemented under consideration.
Some market gurus, including University of Pennsylvania’s Jeremy Siegel, responded by urging the Fed to “take its medicine” and raise a full percentage point. In response to shifting expectations, interest rate futures began pricing in 75 basis points not only in June, but also in July, when the Fed’s policy-setting committee is due to hold its next two-day meeting.
But when it came down to it, Powell chose to give himself enough leeway to make a 50 basis point hike in July, and investors applauded, Tropin said.
Still, there’s always the possibility that more pain is yet to come. Referring to the Fed’s “dot plot” and economic forecasts, Allianz’s Mohammad El-Erian said the “frontline” of Fed rate hikes and the slowdown in economic growth signaled a “stagflationary baseline.” MarketWatch has previously written more about what this could mean for the markets.
Stocks ended Monday’s session higher, with the S&P 500 SPX rising +1.46%, up 1.5% to 3,789, the first daily gain after a historic five-day streak of losses that saw the large-cap benchmark gain more as 10% fell to trade at its lowest since early 2021 as it confirmed its move into a bear market. The Dow Jones Industrial Average DJIA, +1.00% was up a little over 300 points, or 1%. The Nasdaq Composite COMP, +2.50%, closed 2.5% higher at 11,099. Bitcoin BTCUSD, +3.68% ended the day lower but well below its post-Fed lows.
The Cboe volatility index, often referred to as the VIX, ended the day lower at 29.4 but off its session lows as stocks pared gains towards the close. Still, the index made a short-term high above 35 earlier this week.
It is worth noting that the yield on the 5-year TMUBMUSD05Y Treasury bills, 3.375%, remained higher than that of the 30-year TMUBMUSD30Y Treasury bills, 3.333%. While the FOMC’s forecasts didn’t point to a recession and Powell denied that the central bank’s goal is to cause one, the Fed Chair said that higher unemployment is a sign the Fed’s policies are working.
Overall, however, both bonds and equities ended the day higher as the “relief rally” in equities spread to bonds. Whatever happens to the yield curve in the future, it’s likely that long-term interest rates will remain “anchored” as the economy begins to become more stagflationary in character, said Brian Price, head of investment management at Commonwealth, a network of independent broker dealers with $150 billion in assets under management.
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And both stocks and bonds are likely to remain volatile as investors focus on economic data and corporate earnings, which will become a factor when the second-quarter earnings season kicks off next month.
“I don’t think the market will take hold until inflation comes down,” Price said.
And unfortunately, the Fed can do only limited things about it.
“There’s obviously only so much the Fed can do, there’s only so much it can control… there
are other aspects on the supply side. The Fed can’t really influence that
Energy supply, hopefully there will be some improvements,” he said.