The Federal Reserve slowed the pace of its interest rate hikes by hiking 25 basis points meeting market expectations. The Fed also said that the battle against inflation is not complete and will require its benchmark overnight interest rate to be increased further and remain elevated through 2023.
What comes as a hawkish statement might surprise market participants. The Bank of Canada literally said they would pause, but the Fed is saying the terminal rate is still higher. That more rate hikes are coming. Yet the stock markets are popping.
Especially with Fed chair Jerome Powell saying:
“We’ve raised rates four and a half percentage points, and we’re talking about a couple of more rate hikes to get to that level we think is appropriately restrictive,” Powell said. “Why do we think that’s probably necessary? We think because inflation is still running very hot.”
“It would be premature,” he said. “It would be very premature to declare victory, or to think that we’ve really got this.”
So why the reaction in stocks and bonds?
One word: disinflation.
Jerome Powell said this word many times during a dovish press conference. A press conference which many traders are saying that Powell was soft. He had the opportunity to tell the markets that the Fed will continue raising rates, but he came out dovish, just giving bulls a reason to go long risk.
This is the comment which got bulls excited:
“We can now say for the first time that the disinflationary process has started,” Powell told reporters after the end of the Fed’s latest two-day policy meeting, with goods prices slowing, pandemic-related shortages easing, and supply chains getting back to normal. “This is a good thing.”
Disinflation is when prices rise at a slower pace in an inflationary period. For example, CPI rose 6.5% over the prior year in December after having jumped as much as 9.1% over the prior year in July. This deceleration in the pace of price increases is disinflation.
Inflation is falling and the markets think the Fed is close to the terminal rate where the Fed will stop raising rates in this hike cycle. With disinflation, the Fed may be able to complete its current interest rate hike cycle and avoid a severe recession. A soft landing where economic growth slows and inflation comes down, but mass layoffs and a recession are avoided.
As a trader, there was one market I was watching. The bond markets.
Both the 2 year and the 10 year yield declined. Of more interest is the two year yield as it closely follows the Fed funds. Even with the Fed saying they still have more rate hikes to come, yields dropped rather than rising in anticipation of more rate hikes. To me this is very telling.
The US dollar also declined post Fed meeting just emphasizing Powell’s dovish press conference. Although a day later, the dollar is rallying.
When it comes to the stock markets, both the S&P 500 and the Nasdaq are in rally mode. Both rallied hard post Fed meeting. Both have broken out of important technical zones and point to a move higher. Powell did not spook markets, and his soft press conference has traders running back into risk on assets.
However one market isn’t playing along yet:
The Dow Jones is not rallying like the Nasdaq and the S&P 500. The value stocks are lagging. This brings up an interesting point. Perhaps markets are rallying more on earnings. Earnings from the tech giants such as Microsoft, Meta and Coinbase. The latter two are up over 20% post earnings.
Earnings, alongside the drop in yields are very bullish for growth stocks (tech).
But with the Dow Jones not breaking out like the S&P 500 and the Nasdaq, it either means it is lagging and would be a good long, or tech earnings really is the catalyst here instead of the Fed.