One of the most eagerly awaited speeches in recent market memory is now behind us . At the time of writing, after some early gyrations, stocks are now broadly lower in response to Fed Chairman Jerome Powell’s relatively forceful comments.
Although he could have been even more unequivocal about doing whatever it takes to push inflation and inflationary expectations back down to 2%, his words and demeanor conveyed a seriousness about maintaining a hawkish stance on short-term rates.
It seemed as though the Chair was angry about his resolve being doubted. We’ve previously noted that investors seemed to seize upon his “neutral” comment in the last post-FOMC press conference while ignoring his repeated assertions that a restrictive policy would be appropriate. It now appears that he didn’t mind the immediate, forceful pushbacks about “neutral” from his Fed colleagues.
If Mr. Powell paid close attention to the daily moves in stock markets – something I doubt, even though my equity brethren harbor that conceit — he could not have been happy about yesterday’s rally that seemed to materialize out of the thin air of the Grand Tetons. That said, the broad summer rally that has occurred since the FOMC meeting could not have escaped his attention. Maybe that is why the Chair chose more blunt language than usual. The markets, particularly the stock market, seemed to be questioning the Fed’s resolve to fight inflation at all costs.
“The Federal Open Market Committee’s (FOMC) overarching focus right now is to bring inflation back down to our 2 percent goal. Price stability is the responsibility of the Federal Reserve and serves as the bedrock of our economy. Without price stability, the economy does not work for anyone.”
The Chairman then continued with a terse set of comments that built upon that early premise. About eight minutes later he concluded with this:
“We are taking forceful and rapid steps to moderate demand so that it comes into better alignment with supply, and to keep inflation expectations anchored. We will keep at it until we are confident the job is done.”
Importantly, unlike last time, the parade of Fed Governors seems to share the Chairman’s message. Any disagreement is about specific rate targets and the pace of tightening, not about whether those will persist, let alone when they will reverse course. Still, Fed Funds futures continue to show that rates will peak at about 4% in March, then a slight likelihood that they will decline thereafter. A quarter-point cut is priced in for June 2023. The implication behind that assumption must be that a severe recession will force the Fed to reverse course, or perhaps that the Fed will be so successful in stamping out inflationary expectations that they can change their minds. The former could have dire consequences, while the latter seems like a remote possibility.
In yesterday’s piece we created a tongue-in-cheek decision rubric that took aim at traders’ tendency to take away the positives from “Goldilocks in a Suit’s” comments. At first, that appeared to be the case. As Powell’s comments hit the wires, the first reaction was sharply negative. Then, somehow, stocks rallied back to a slight gain. Buy the dip? Sell the rumor, buy the news, despite having bought the rumor yesterday? At the time, I jested:
What they heard: “At some point…it likely will become appropriate to slow the pace of increases.”
Since then, maybe because cooler heads prevailed, or maybe because of the solidarity between the Chair and his colleagues, stocks continued their declines. It was clear that most traders heard nothing in the speech that would spark a continuation of yesterday’s rally.
That said, today’s decline 2% decline in SPX looks much more severe because of yesterday’s 1.4% rally. The old adage of “don’t short a dull tape” was put into practice yesterday. We failed to sell off, so the next move was higher. That’s normal, that’s trading. But in a market that already saw volume depressed by summer vacations, the sparse liquidity ahead of a major speech allowed a minor bounce to become a major leap higher. The following chart shows not only today’s 10AM head fake, but also that the bulk of today’s decline is merely retracing yesterday’s late, low volume rally:
Source: Interactive Brokers
We all know that strange things can occur when volumes are light, and there is little reason that volumes will pick up markedly before the Labor Day holiday on September 5th. We also know that markets have a nasty history of volatility in the September/October period. The VIX index, which offers the option market’s expectation for volatility over the coming 30 days, has pushed up to nearly 24 after hovering around 20 recently.
Even after that bump, however, VIX is still below the levels that were customary earlier this year. Please keep that in mind as summer comes to a close and with Goldilocks, er, Chairman Powell, scheduled to give another press conference less than a month from now, on September 21st, after the next FOMC meeting.
[i] I was tempted to put this in the main body of today’s piece, but it seemed inappropriate. For those of you who know of my love of the film “Trading Places”, the 2:25 mark of this clip sums up traders’ behavior this morning.
Disclosure: Interactive Brokers
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