I said it was going to be wild week last week, and was it ever! The key point was the Fed’s ‘mini taper’, which I discussed here. Yes, the Fed said they expect two interest rate hikes at the end of 2023, but they raised the Interest on Excess Reserves (IOER) by 5 basis points. Something not being mentioned by too many financial outlets, but represents a change in policy.
Stock markets sold off initially on the Fed’s words as they began to price in tapering. I argue that the increase on the IOER was in itself, the Fed letting banks and the markets know they are preparing for a change in policy. During the Fed press conference, Jerome Powell said that Fed members are now talking about thinking to taper. Those few words made a major impact.
I tend to not trade much after the Fed meeting just to allow the market to digest all the information that was said. Sometimes stocks over react on what was said.
The Dow Jones was the index getting the largest hit. On Thursday last week, CNBC headlines said the Dow performance for the week was the worst since January of 2021. That changed dramatically on Friday last week. Further sell off took the Dow weekly performance to be the worst since October 2020.
The cause of this sell off? This man:
St. Louis Fed President Jim Bullard came out and said that he sees an initial rate hike sooner than the end of 2023. Inflation pressures may force the Federal Reserve to hike rates as early as 2022 (late 2022). Markets fell on fears of a taper sooner rather than later. The taper tantrum analysts and economists have been talking about. His comments are being referred to as the “Bullard Bomb”.
“Overall, it’s very good news,” Bullard said of the economic trajectory during the reopening. “You love to have an economy growing as fast as this one, you love to have a labor market improving the way this one has improved.”
However, he cautioned that the growth is bringing faster-than-expected inflation, adding that “you could even see some upside risks” to price pressures that by some measures are running at their highest levels since the early 1980s.
That’s why he thinks it would be prudent to start raising interest rates as soon as next year. The Fed dropped its key overnight lending rate to near zero at the outset of the pandemic and has kept it there since.
I mentioned earlier that I tend not to trade after the Fed press conference. I like markets to digest what was said. This tends to lead to large moves in the indices and currencies. At that point, I feel like I am chasing if I was not already in a position. What I like to do is first to see if a new trend has begun, and then play the pullbacks, or next swing.
For those who are members of Equity Guru’s Free Trading/Investment Discord Channel, you will recall me lamenting about the Dow Jones daily close on Friday. It was bad. The worst out of all the other major indices due to the breakdown occurring on the larger daily chart.
Regular readers of Market Moment can see why I did not like the breakdown. We had the uptrend, then the range, and the breakdown hints to a new downtrend.
A very strong recovery in all markets at time of writing. To be honest, this is what I was expecting. Remember: pullbacks are normal, especially on a breakdown or breakout. In this case, we tend to see price pullback to retest the breakout/down zone before continuing the momentum.
Basically like what is happening now. The key today is how this daily candle closes. If the daily candle closes just like it looks right now, it would be safe to say this was a fake out. But if by the end of the day, we close back below the 33,600 zone, then the chance of a continuation lower continues. We still have a lot of time in today’s trading session, so anything can happen.
Financial media is giving us two reasons for this drop in the Dow Jones. The first is of course the fear of the Fed tapering. The taper tantrum which has been exacerbated by the “Bullard Bomb”. But ask yourself this going forward: can interest rates even rise due to all the debt out there? Answer this, and you will have a good idea where stocks will go. In fact, we can even say that the markets could be calling the Fed’s bluff. They don’t believe the Fed will act and hence, will move higher.
The second reason given for this Dow Jones sell off has been the rotation. The rotation out of value stocks and into growth stocks. Essentially money leaving the Dow and heading to the Nasdaq. At first, this sounded reasonable because the Nasdaq was holding up strong while other indices fell. However, the Nasdaq also fell under pressure after the Fed meeting. The tech index is still holding up strong, so we will watch to see how both the Dow and Nasdaq move and if indeed, there will be a more pronounced and obvious divergence.
So if the Dow does eventually close below our zone today, how much lower can we go? I would be looking around the 32,000 zone. Economist Mark Zandi believes stocks could correct somewhere between 10-20%.