Financial markets suffered an absolute bloodbath in the days leading up to Wednesday’s Federal Reserve decision, with stocks plunging and bond yields soaring in the wake of surprisingly hot inflation data — a sign that investors feared a more Volcker-esque reaction from Federal Reserve Chairman Jerome Powell and the rest of the Federal Open Market Committee.
But now that the dust has settled, it looks like Powell couldn’t help but be himself — and stocks and bonds thanked him for it after the Fed delivered a 75 basis point hike to the fed-funds rate, its largest such move since 1994.
After a muted initial reaction that saw the Treasury yield curve briefly invert, prices of bonds, stocks and even cryptocurrency prices rallied as Powell left enough wiggle room on the size of the hike that investors can expect at the July meeting, with Powell saying that he could go with 75 basis points or 50 basis points — and that the Fed would, as always, remain data dependent.
“I think we came into this meeting people were really fearing the worst, that we were going to not just get the 75 basis points, but that he would talk very hawkishly,” said Kenneth G. Tropin, founder and chairman of Graham Capital Management, a macro hedge fund, managing $18 billion. “In the end he didn’t do that, he wisely gave himself some optionality.”
Instead of shocking markets with a more hawkish tone, Powell was “more diplomatic, more measured. But that’s who he is,” Tropin added.
In the end, it looks like the market may have gotten ahead of itself during the recent selloff as investors braced for Wednesday’s 75 basis point hike, expectations that appeared to be cemented by a report in The Wall Street Journal on Monday indicating the outsize move was under consideration.
Some market gurus, including the University of Pennsylvania’s Jeremy Siegel, responded by calling for the Fed to “take its medicine” and hike by a full percentage point. In response to the shifting expectations, interest-rate futures began pricing in 75 basis points not just in June, but in July as well, when the Fed’s policy-setting committee will hold its next two-day meeting.
But when it came down to it, Powell opted to leave himself enough room to go with a 50 basis point hike in July, and investors applauded, Tropin said.
Still, there’s always the possibility of more pain ahead. When it comes to the Fed’s “dot plot” and economic projections, Allianz’s Mohammad El-Erian said the “front-loading” of the Fed’s rate hikes as well as the decline in the pace of economic growth signaled a “stagflationary baseline”. MarketWatch previously wrote more about what that might mean for markets.
Stocks finished Monday’s session higher, with the S&P 500 SPX, +1.46% up 1.5% at 3,789, the first daily gain after a historic five-day string of losses that saw the large-cap benchmark fall more than 10% to trade at its lowest since early 2021 as it confirmed its fall into a bear market. The Dow Jones Industrial Average DJIA, +1.00% rose a little over 300 points, or 1%. The Nasdaq Composite COMP, +2.50% finished 2.5% higher at 11,099. Bitcoin BTCUSD, +4.00% finished the day lower, but well off its post-Fed lows.
The Cboe Volatility Index, often referred to as the VIX, finished the day lower at 29.4, but off its lows of the session as stocks trimmed their gains heading into the close. Still, the index hit a near-term high above 35 earlier this week.
It’s worth noting that the yield on five-year Treasury notes TMUBMUSD05Y, 3.375% remained higher than those of 30-year Treasury bonds TMUBMUSD30Y, 3.333%. While the FOMC’s projections didn’t portend a recession, and Powell denied that it was the central bank’s aim to cause one, the Fed chairman did say that higher unemployment would be a sign that the Fed’s policy prescription is working.
Overall, however, both bonds and stocks finished the day higher, as the “relief rally” in stocks extended to bonds. Whatever happens going forward with the yield curve, it’s likely that long-term rates will remain “anchored” as the economy begins to take on more of a stagflationary flavor, said Brian Price, head of investment management, Commonwealth, a network of independent broker dealers which has $150 billion under management.
And both stocks and bonds will likely remain volatile, as investors zero in on economic data as well as corporate earnings, which will become a factor when the second-quarter earnings season begins next month.
“I don’t think the market will find its footing until inflation has come down,” Price said.
And unfortunately, there’s only so much the Fed can do about that.
“The Fed can only do so much obviously they can only control so much…there
are other aspects on the supply side. The Fed can’t really influence
energy supply, hopefully there will be some improvements,” he said.