Why stocks and bonds went into relief rally mode after the Fed’s rate hike

Financial markets suffered an absolute bloodbath in the days leading up to Wednesday’s Federal Reserve decision, with stocks plunging and bond yields climbing in the wake of surprisingly hot inflation data – a sign investors feared a more Volcker-esque reaction from Federal Reserve Chairman Jerome Powell. and the rest of the Federal Open Market Committee.

But now that the dust has settled, it looks like Powell couldn’t help but be himself – and stocks and bonds thanked him for it after the Fed hiked the funds rate by 75 basis points. federal government, its largest measure since 1994 .

After a muted initial reaction that saw the Treasury yield curve briefly invert, bond, stock, and even cryptocurrency prices rose as Powell left ample leeway on the scale. of the upside investors can expect at the July meeting, with Powell saying he could go with 75 basis points or 50 basis points – and that the Fed would, as always, remain dependent on data.

“I think we came into this meeting people were really fearing the worst, that we weren’t just going to get the 75 basis points, but he was going to be talking very belligerently,” Kenneth G. Tropin said, founder and president of Graham Capital Management. , an $18 billion macro hedge fund. “In the end he didn’t, he wisely gave himself an option.”

Instead of shocking the markets with a more hawkish tone, Powell was “more diplomatic, more measured. But that’s who he is,” Tropin added.

Ultimately, it looks like the market got ahead of itself in the recent selloff as investors braced themselves for Wednesday’s 75 basis point rise, expectations that seemed to be cemented by a Wall Street Journal report Monday that the outsized move was being investigated.

Some market gurus, including Jeremy Siegel of the University of Pennsylvania, responded by calling on the Fed to “take its medicine” and raise a percentage point. In response to changing expectations, interest rate futures began to settle at 75 basis points not only in June, but also in July, when the Fed’s policy committee will hold its next two-day meeting.

But in the end, Powell chose to give himself enough room to pull off a 50 basis point hike in July, and investors cheered, Tropin said.

Yet there is always the possibility of more pain to come. Regarding the Fed’s “dot plot” and economic projections, Mohammad El-Erian of Allianz said the “frontloading” of Fed rate hikes along with the declining pace of economic growth signaled a “stagflationary baseline”. MarketWatch has already written more about what this could mean for the markets.

Stocks ended Monday’s session higher, with the S&P 500 SPX,
+1.46%
up 1.5% to 3,789, the first daily gain after a historic five-day losing streak that saw the large-cap benchmark fall more than 10% to trade at its lowest since the early 2021 as it confirmed its fall into a bear market. The Dow Jones Industrial Average DJIA,
+1.00%
increased by just over 300 points, or 1%. The Nasdaq Composite COMP,
+2.50%
ended 2.5% higher at 11,099. Bitcoin BTC USD,
+3.58%
ended the day lower, but far from its post-Fed lows.

The Cboe Volatility Index, often referred to as the VIX, ended the day down at 29.4 but off its session lows as stocks pared gains near the close. Still, the index hit a short-term high above 35 earlier this week.

It should be noted that the yield of five-year Treasury bills TMUBMUSD05Y,
3.375%
remained higher than those of the TMUBMUSD30Y 30-year Treasury bills,
3.333%.
Although the FOMC’s projections do not point to a recession and Powell denied that the central bank’s objective was to cause one, the Fed Chairman said higher unemployment would be a sign that the Fed policy prescription was working.

Overall, however, bonds and equities ended the day higher, with the “relief rally” in equities extending to bonds. Whatever happens going forward with the yield curve, long-term rates are likely to remain “pegged” as the economy begins to take on a more stagflationary flavor, chief investment officer Brian Price said. investments, Commonwealth, a network of independent brokers. dealerships that has $150 billion under management.

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And stocks and bonds are likely to remain volatile as investors focus on economic data as well as corporate earnings, which will become a factor when the second quarter earnings season begins next month.

“I don’t think the market will find its footing until inflation comes down,” Price said.

And unfortunately, the Fed can’t do much about it.

“The Fed can’t do much, obviously they can only control so much…there
are other aspects of the supply side. The Fed can’t really influence
energy supply, I hope there will be improvements,” he said.

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