The US stock markets are sliding in reaction to yesterday’s released FOMC minutes. Notes from the Fed’s meeting last month and gives us an idea on what voting members are thinking.
Powell and the Fed told us in the December meeting that interest rates will remain higher for longer. Pre-maturely cutting interest rates with the inflation genie not back in the bottle would lead to higher and entrenched inflation. The terminal rate given was 5.1% (or rate hikes up to 5.25%) and the Fed said they would not cut interest rates until 2024.
When this data came out in December, the markets were calling the Fed’s bluff. I spoke about a chart which looked like it was going to reverse and was indicating the markets were betting the Fed would not stick to its hawkish comments and actually cut rates. More on that chart later.
The FOMC minutes confirmed the Fed’s hawkish intent. Here are some key points:
“Participants generally observed that a restrictive policy stance would need to be maintained until the incoming data provided confidence that inflation was on a sustained downward path to 2 percent, which was likely to take some time,” the meeting summary stated. “In view of the persistent and unacceptably high level of inflation, several participants commented that historical experience cautioned against prematurely loosening monetary policy.”
“A number of participants emphasized that it would be important to clearly communicate that a slowing in the pace of rate increases was not an indication of any weakening of the Committee’s resolve to achieve its price-stability goal or a judgment that inflation was already on a persistent downward path,” the minutes said.
“Participants generally indicated that upside risks to the inflation outlook remained a key factor shaping the outlook for policy,” the minutes said. “Participants generally observed that maintaining a restrictive policy stance for a sustained period until inflation is clearly on a path toward 2 percent is appropriate from a risk-management perspective.”
Some key points here. First off, slowing rate hikes is not pivoting like some market participants think. Interest rates will remain high until the Fed sees multiple months of CPI falling. Risks remain for upside inflation but downside for growth.
But here is perhaps the most interesting comment from the FOMC minutes:
“Participants noted that, because monetary policy worked importantly through financial markets, an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the Committee’s reaction function, would complicate the Committee’s effort to restore price stability.”
Fed officials were not happy with the surge in the stock markets which the markets are doing because they believe the Fed is pivoting… when they are not. This will lead to a volatile move in markets once the markets wake up to the fact that the Fed is remaining on the course to do what is necessary to tame inflation. That interest rates will remain higher for longer.
US stock markets are still adhering to my technicals which I have been laying out in recent Market Moment articles. More downside until the stock markets can confirm a close above resistance. The S&P 500 would need a close above 3930, and the Dow Jones above 33,450 for the downtrend to be nullified.
The positive thing for bulls is ever since the markets broke down in December, they have just been ranging rather than falling. This could be a sign that the downside momentum is weak and markets will reverse. However, I want to remind readers that the break occurred during a period of low liquidity in December. I would expect a range in that market condition. Normal volume and liquidity is making its way back.
The US Dollar also appears to have reached its bottom side targets after a breakdown. The Dollar is now ranging at support, and today’s candle close hints at a breakout and reversal. The Dollar continues its long term uptrend after this brief pullback. This will hit markets as this dollar strength is due to a hawkish Fed.
The most important charts for us market participants remain those of the bond markets. Above is the chart of the 2 year yield. This market closely follows the Fed rate. A reversal pattern known as the head and shoulders looked like it was about to trigger. And this was post Powell hawkish December statement. Powell was saying one thing, and the bond markets were not believing it.
However, the head and shoulders pattern did NOT trigger. Instead we bounced and headed higher. The type of reaction one would expect after a hawkish Fed.
A trendline is broken which means the probabilities for higher yields (thus market expecting higher interest rates) is high. If the Fed sticks with its terminal rate of 5.1% (5.25%), then expect the 2 year yield to take out recent highs at 4.90%.
In summary, don’t bet against the Fed. The big event which could come from left field is a recession, however labor data still remains robust and the Fed has pointed out that strong employment numbers do not indicate an economy slowing down.