U.S. stocks and bonds rallied on Wednesday, much to the chagrin of traders who had ramped up bearish bets on the expectation that Federal Reserve Chairman Jerome Powell would push back against the market’s latest advance.
Now, the question on most traders’ minds is: With Powell out of the way, do markets have the all-clear to keep on chugging?
It’s very possible, market strategists said, citing Powell’s remarks about financial conditions during Wednesday’s press conference, which followed the Fed’s decision to hike interest rates by another 25 basis points.
According to market strategists, the upshot is that instead of trying to corral or push back against markets, Powell has decided to disregard their latest moves, treating them as insignificant, or as further evidence that the Fed’s tactics to curb inflation are working without much blowback to the real economy or labor market.
During the opening minutes of the question-and-answer session segment of Wednesday’s press conference, Powell said financial conditions had tightened substantially and that the Fed was no longer concerned with short-term fluctuations.
U.S. stocks seemed to jerk higher in response, as market strategists said Powell seemed to be signaling that higher equity prices and lower bond yields are no longer a threat to the Fed’s inflation-fighting mission.
Some even took issue with Powell’s underlying claim, arguing that according to at least one popular measure, financial conditions are little-changed from a year ago. Among them was Allianz’s Mohamed El-Erian, who sounded off in a tweet, saying “Not sure which index he is using. The most widely cited ones show overall financial conditions as loose as they were a year ago.”
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Financial-conditions indexes are supposed to reflect the impact that fluctuations in markets and exchange rates are having on the real economy, according to Guy LeBas, chief fixed-income strategist at Janney, in a phone interview.
By not pushing back when asked, Powell has given equity and bond markets “tacit approval” to keep on rallying, LeBas said.
Others took a similar view.
“The fact that Powell thinks that financial conditions have tightened, when they have eased across a range of metrics in recent months, is dovish,” said Neil Dutta, head of economics at Renaissance Macro Research, in a tweet.
Market participants had seemingly become “obsessed” with the notion that Powell and the rest of the FOMC would push back against looser financial conditions during the run-up to Wednesday’s meeting, LeBas said. This belief even helped rattle U.S. stocks in the days ahead of the Fed meeting, market strategists said.
Instead, Powell repudiated this notion, and rightfully so, according to LeBas, since the impact that market swings have on inflation is rarely so direct.
“Stable FCIs at a relatively high level…will also work to constrain activity. In that respect, we don’t believe Fed policymakers spend as much time today obsessing over FCIs as market participants seem to think,” LeBas said in a note to clients. That view turned out to be vindicated.
The Chicago Fed’s National Financial Conditions Index shows substantial easing since October. It currently stands at -0.35, compared with roughly -0.11 in mid-October. Higher equity prices and lower bond yields correspond with a lower number on the index. Bond yields move inversely to bond prices.
By comparison, the index was much lower before the Federal Reserve started hiking interest rates in March 2022. It stood at -0.60 on Dec. 31, 2021.
The S&P 500
SPX,
+1.05%
gained 42.61 points, or 1.1%, on Wednesday to finish at 4,119.21, its highest level since August. For the Nasdaq Composite
COMP,
+2.00%,
it was the highest close since September. The yield on the 2-year Treasury note
TMUBMUSD02Y,
4.112%
fell by roughly 8 basis pints to 4.125%, while the yield on the 10-year note
TMUBMUSD10Y,
3.407%
fell by 10.4 basis points to 3.442%. U.S. stocks saw substantial gains in January, with the S&P 500 rising more than 6%, while some of the most speculative stocks saw even larger gains. The S&P 500 fell by 19.4% in 2022.
The U.S. Dollar Index
DXY,
-0.28%,
a gauge of the buck’s strength vs. a basket of its main rivals, fell by 0.9% to 101.14.
Of course, this wasn’t always the case. For a while last year, it seemed that the Fed viewed rallies in markets as a direct affront. Wednesday’s reaction is a far cry from how markets responded to Powell’s fire-and-brimstone speech at Jackson Hole in August. Back then, Powell delivered a terse statement where he said the Fed would continue with its rate hikes despite the likelihood that U.S. businesses and households would suffer.
Many market commentators said his August remarks appeared calibrated to push back on a rally in stocks and bonds driven by premature hopes for a Fed pivot. If this was the case, then they had their desired effect: The S&P 500 fell to fresh lows a few weeks later.
Powell has a good reason for abandoning this strategy, according to LeBas.
“The impulse from financial conditions has already done its job,” he said.
With Powell out of the way, will stocks drift higher from here? It’s possible, market strategists said. But there are other factors that could trip them up.
Corporate earnings are one possible candidate. Profits are on track to fall by 2.4% in the fourth quarter compared with 2021, according to Refinitiv data.
However, S&P 500 stocks are still on track to outperform Wall Street’s relatively low expectations, according to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.
