A “Dovish Hike” Is Not an “All-Clear”

This week has the potential to be a wild one.  A slew of earnings and central bank decisions offer the possibility to shake equity markets out of their recent complacency.

After tomorrow’s and Wednesday’s closes we learn about the sustainability of the recent artificial intelligence (AI) craze when 3 of the Magnificent Seven” companies that have done much of the heavy lifting for year-to-date equity index returns report 2Q earnings.  Tomorrow we hear from Microsoft (MSFT) and Alphabet (GOOG, GOOGL).  As a scrappy #2 and a definite #1 in search, the stocks have benefitted tremendously from enthusiasm about AI.  They are also enormous, representing about 13% and a combined 7% of the NASDAQ 100 Index (NDX) respectively, along with about 6.7% and 3.5% of the S&P 500 (SPX).  A significant move from one or both of those companies will have a pronounced effect on those indices – unless one gains at the other’s expense.  META’s index weights are smaller, at 4.25% and 1.7%, but that stock’s rebound has been turbocharged by the rapid adoption of its Twitter competitor, Threads.  We will learn about whether this is likely to have a meaningful effect on META’s bottom line, or if many new adopters are like me – someone who downloaded the app, set up a profile, then did nothing with it. 

Although it is still too early in this earnings season to draw definitive conclusions, my early hypothesis is that better performing stocks have higher earnings day hurdles than relative underperformers.  We wrote about this on Thursday, when high-flying Tesla (TSLA), Netflix (NFLX) and Taiwan Semiconductor (TSM) all beat their consensus expectations for earnings per share (EPS) but fell sharply nonetheless when investors focused on the totality of their reports.  Meanwhile, Goldman Sachs (GS) missed its number and has rallied ever since, and Zion’s Bancorp (ZION) rose 10% after a 2 cent beat.  If this pattern holds, it raises the stakes for the remaining mega-cap tech companies that have powered major US indices.

Yet as important as any of these companies might be, they pale in comparison to central banks.  The Federal Reserve announces the results of its upcoming two-day meeting on Wednesday, followed by the European Central Bank (ECB) on Thursday and the Bank of Japan (BOJ) on Friday.  The market consensus seems to be centered upon the idea of a “dovish hike”, which I take to mean that the FOMC will signal that this week’s widely expected 25 basis point hike will be the last and that monetary policy rhetoric will soften.  While this hike may indeed prove to be the last, I find it unlikely that the Fed will change its tough rhetoric.  Inflation is certainly under better control than it has been, but it still remains about 4% by most key measures –including the Fed’s preferred Core PCE deflator.  Last time I checked, 4% is still above the Fed’s 2% target.  It seems like wishful thinking to expect the FOMC to signal anything other than continued vigilance in its fight against inflation, keeping quantitative tightening (QT) in place and leaving the possibility for further hikes – not cuts – on the table. 

Of course, what Chairman Powell says at the ensuing press conference – and even more importantly, what traders chose to hear. We have noted about Powell’s tendency to soften his message when addressing a roomful of reporters, writing after the last FOMC meeting:

Yesterday, as usual, we wondered whether “Goldilocks Powell” would make an appearance at the press conference, undermining a hawkishly-worded statement.  It seemed as though the Chair tried, but that Powell can’t help his Goldilocks tendencies.  It occurs to me now that the Jackson Hole speech was given directly into the camera while standing on the prairie.  In a room full of reporters — some adversarial, some fawning, but all respectful – his nature is to answer with respect.  That blunts any intended negative messaging.

“It’s not what you say, it’s what people hear,” is the professional mantra of a friend from college who has based a lucrative career on that mantra.  Chair Powell may want to take that phrase to heart.  Stocks jumped when he clearly stated that the July meeting would be “live.”  He likely intended that to mean that hikes would be back on the table.  A hop, skip, and a jump, if you will.  What the market heard instead was “we have a chance that we’re done.” 

In a recent televised interview, I was asked about which of the three might be the most likely to move markets.  I was prepared to answer “BOJ”, but reports emerged that morning about leaning toward their keeping yield curve control policy unchanged.  A relaxation to that policy would be a sea change to a key economy’s monetary conditions and have ramifications for global bond markets.  Since then, we have seen reports that the BOJ might up its inflation targets, which puts a policy tweak back on the table.  An “in-play” BOJ meeting certainly could be a market moving event.  And although the consensus for a 25 bp hike remains a near-certainty for the ECB, this morning’s shockingly bad European PMI reports may give President Lagarde and her colleagues some pause about future rate policy.

Yet the Cboe Volatility Index (VIX) continues to yawn with a reading below 14.  Remember, the most painful surprises occur when they are NOT priced into the market.  And the market does not seem to be pricing in surprises now.