Central Banks

Market Reaction to the Fed Shows Continued Optimism, But Will It Last?

Federal Reserve Chairman Jerome Powell
Credit: Pool - Reuters / stock.adobe.com

Regular readers of my musings, should such a thing exist, will be aware that when major data or news are released, I am usually more concerned with the market’s reaction to the news than with the news itself. That is in part because my first market experience was in a dealing room, where all that really mattered was the next quoted price.

In that environment, it often seemed that one could operate in a complete vacuum, aware only of pricing and essentially ignoring any fundamental influence on the thing being traded. It didn’t matter why the bid had gone from 30 to 50, only whether you were long or short when it did.

However, as time has gone by and my trading and investing horizons have lengthened, I have retained my fascination with the market reaction to news, and yesterday’s events showed why.

A lot of people were surprised that on a day when Jay Powell and the FOMC adopted their most hawkish tone so far when talking about future rate cuts, or more accurately one future rate cut, the market held up so well. Yes, the Dow closed the day a bit lower, but that was more than offset by a strong day for the Nasdaq, and the S&P 500 closed above 5400 for the first time.

So why did that happen? Why did the supposedly interest-sensitive tech sector lead the way on a day when the Fed indicated only one rate cut this year, something that just a few months ago was seen as a disastrous possibility?

If you have been paying attention to the market's reactions to news over the last few months, you will know exactly why. Those reactions said quite clearly that traders and investors decided a while ago that one cut, or even possibly no cuts at all this year, was the most likely scenario. Importantly, they also decided that that didn’t matter. Tech companies, fueled by the opportunities presented by AI, were doing just fine with rates where they were, and holding steady for longer didn’t look like it would hurt.

The market reactions to news and data have indicated for three months or so that traders felt that way and and it was obvious enough for me to point it out as early as March 27th this year. They are far more focused on performance than on the prospect of rate hikes and, as Broadcom's (AVGO) results yesterday afternoon showed once again, that performance, at least amongst the leaders in supplying the AI boom, is absolutely stellar.

This is important because it means that while there is always a danger of a rapid pullback when the market is being supported by strength amongst a quite narrow, concentrated group of stocks as is the case now, there is no reason to believe that the rally will be derailed any time too soon. If traders and investors can shrug off the news that we have been told for a year or so was what they were afraid of and still push the S&P to record highs above a psychologically significant level, then it is hard to think of anything that might prompt a major correction.

My one hesitation is that while most people didn’t see it that way when I wrote the article back in March, the “cuts don’t matter” view is now conventional wisdom. That seeming unanimity of view is, of course, a bullish influence in the short-term, but it does lead to a dangerous situation where even a small move down could trigger a rush to exit a crowded trade and prompt some selling that seems almost panicky.

That means that even though I expect the rally to continue, I will be exercising some caution. In particular I will be keeping a close eye on data releases over the next few weeks, or more accurately, the market reaction to them. If there is an “illogical” downside reaction to some seemingly innocuous data or news, it will be a sign that market sentiment has shifted from its current focused optimism and, even if the news and numbers themselves remains positive, that will be a sign that a correction is coming and will, in turn, mark a good time to start taking some profits.

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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