We knew that the Federal Reserve (Fed) Chair Jerome Powell would not tell investors ‘Ho ho ho, inflation is now 7%, we will stop tightening policy and hiking the rates. So, you can buy stocks, bonds, cryptocurrencies, meme stocks, whatever you find. Merry Xmas!’
No, he was not going to do that, and he did not.
As expected, the Fed raised its interest rates by 50bp to 4.25/4.50% range, the dot plot showed that the Fed officials’ median forecast for the peak Fed rate rose to 5.1%.
Plus, the distribution of rate forecasts skewed higher, with 7 officials out of 19 predicting that the rates could rise above 5.25%
Moreover, the inflation forecast for next year was revised higher DESPITE the latest decline in inflation.
And the median rate forecast for 2024 was revised higher to 4.1%.
In summary, the FOMC message was very clear: the Fed is not ready to stop hiking rates – even though they will be hiking by smaller chunks.
Jerome Powell said yesterday that the last two CPI reports were ‘a welcome reduction in the monthly pace of inflation’, however, ‘it will take substantially more evidence to have confidence’ that the job is done.
Crystal clear. No pause, no cut, no softening in sight.
Waking up from a dovish dream
US equities woke up from a dovish dream with a cold shower yesterday.
What’s interesting is, some investors still wanted to ignore the hawkish Fed comments and buy the dips, because the new Fed trade is no longer about how high the Fed rate will go but ‘how soon the Fed will start cutting the rates again’.
But that reasoning has limits, as it ignores the additional pain that the stock markets should endure due to an eventual recession – the trigger for rate cuts expectations – which could trigger a fresh wave of sharp selloff.
As a result, the S&P500 closed the session 0.60% lower, and there is a stronger case building for a deeper downside correction toward and below the 100-DMA, 3930, than a ytd trend reversal with a third, and successful push above the 4100 resistance. The falling earnings expectations and slowing economic activity is the next challenge for stock investors as the risk of another, and a sharp selloff is still very much alive. Same for Nasdaq. The index closed 0.80% lower after the Fed decision, and will likely re-test the support at 11430/11450, and eventually clear it.
So for those who wanted to see Santa come around this Xmas: he will probably be stuck somewhere in the snow.
USD rebound should remain limited
The US dollar index rebounded from the lowest levels since summer, yet the dollar appetite will likely remain soft, and the rallies will likely be seen as interesting opportunity to sell the top against other majors, given that the Fed’s hawkishness has been wildly priced since mid-2021, and a further downside correction would not be surprising, even though it’s somewhat counterintuitive to rush back to majors like the euro, which deals with a terrible energy crisis and faces a severe recession if it’s not already in one, the pound, which is hammered by economic and political disasters in the UK, amplified by the Brexit’s consequences, and the yen, where the BoJ refuses to take a policy action, letting inflation run hot by keeping rates in the negative territory…
Not the same 50bp
Today, the European Central Bank (ECB), the Bank of England (BoE) and the Swiss National Bank (SNB) are also expected to hike the rates by 50bp to tame inflation in Europe.
But the ECB’s and especially the BoE’s 50bp hike will likely sound more dovish than the Fed’s 50bp hike.
The ECB is expected to revise its inflation forecast higher – which justifies a rate hike, but pull its growth predictions lower – which doesn’t make a rate hike seem ‘that’ right.
If the ECB officials could spit out a date for the start of the QT, that would be a good thing.
The tighter ECB policy – and if all goes well, a softer US dollar – is expected to give further support to the single currency in the coming months, and help the pair extend gains toward the 1.10 mark.
And the euro recovery is one thing that could tame a part of inflationary pressures, making the raw material and energy costs more affordable for European businesses and households.
Across the Channel, the BoE is also expected to hike by 50bp, but try not to boost the BoE hawks. Data released yesterday showed that inflation in Britain slowed to 10.7% in November, which is not a victory, but the economic difficulties in Britain will likely keep the BoE’s hands tied.
And finally in Switzerland, the National Bank is also expected to raise the rates by 50bp to keep up with the others. The strong franc has been the SNB’s best arm in its fight against inflation. And a 50bp in Switzerland – where the inflation is around 3%, which makes it three times lower than inflation in Europe and around two times lower than inflation in the US – is a bigger hike in real terms, and should further support the franc. The dollar-franc is expected to fall to 0.88/0.90 range in the continuation of the actual bearish trend.
