Central Banks

How Will Stocks React to This Week's Fed Announcement?

Jerome Powell
Credit: Brendan Smialowski/Pool via REUTERS

Over the last few weeks, as the stock market has rebounded off the October 13 lows, traders and investors have ostensibly been focused on multiple data points relating to the economy and the market. GDP numbers, inflation data and earnings have all moved the needle but, no matter how much we may tell ourselves that those things matter, everything is still being filtered through the big daddy of all influences right now: the Fed. We will hear from them this week. The market is confident that they know what the Fed will do at this meeting, that they will hike rates by another three-quarters of one percent, but they are waiting to hear what the Fed has to say after that meeting. Will there be a hint of a pause, or a commitment to “consistency” that suggests they will keep hiking rates until real damage is done?

At times like this, with speculation running rife, the market’s forward-looking nature can lead to the kind of fluctuations based on very little that can look ridiculous when the context is stripped away. A drop in the 3-month rolling average of the rate of growth of core PCE, for example can lead to a strong rally, even though inflation is still running at its highest levels since the 1980s. Similarly, GDP growth of 2.5% looks strong following two consecutive quarters of negative prints, but it can cause a wobble in stocks all the same. In both cases, the data itself isn't what's driving the move; it is how readers and investors think those numbers will influence the Fed.

Fed Chair Jerome Powell has said that the Fed is following the average of core PCE, an inflation metric that considers how consumers change their buying patterns as well as their total spend in response to rising prices, as the primary indicator of inflation in the economy. He has also said, however, that they are aware of the danger of overdoing it and forcing the economy into an unnecessary recession. So, a moderation in the growth rate of core PCE can result in a significant rally because it suggests that the Fed has a handle on inflation and may change course before too long. Meanwhile, a decent GDP number is seen as indicating resilience in the economy and therefore a likely delay in any pause or policy reversal and can cause a counterintuitive drop in stocks.

We have reached the point, however, where the convoluted thinking is being overdone. Yes, even a slight change in the trend of core PCE can be positive and strong GDP numbers may delay a policy reversal but taken together, they indicate that despite a series of aggressive rate increases by the Fed that have started to moderate inflation, the U.S. economy grew in the third quarter. In other words, we are in a good place.

That leaves an important question unanswered: Will the delicate balance that the data indicates lead to overconfidence? Will it make the FOMC push too far for too long, repeating the mistake that got us into this mess, only in reverse?

History suggests it will. The resilience of the American economy has been one of its greatest features for decades, and is the thing that has enabled it to withstand meddling from the Fed over the last fifty years or so. Of course, the central bank has a duty to intervene at times of crisis, but it has always been reluctant to shift to neutral when the data begins to indicate that they are achieving their goals. However, this time there is hope. Jay Powell has at least said he is aware of the risks, which is a good start.

There is a good chance he will reiterate that, even if the committee does hike rates by another 75 basis points this week, which severely limits the downside risk for stocks. There is, I suppose a faint chance that the FOMC looks at the situation as one where inflation is continuing and GDP is bouncing back, and therefore hikes by a full point, but that is extremely unlikely. It is, however, easy to see them hiking by the expected amount and hinting at a time when they will pause to assess the impact of “normalized” interest rates.

As to what all that means for markets this week, it suggests an opportunity. Traders know the history of the Fed and don’t have a lot of confidence in Powell right now, so they will probably start the week in a cautious mood and stocks will move lower over the next couple of days. However, it is hard to see how he can mess this up given that the data is on his side. While the initial reaction to the announcement may be negative, the selling will probably turn out to be a consolidation move that sets up for a push higher later this month.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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