Stock Market Shocked by Fed Doing What Everyone Expected

Yesterday, the stock market was shocked, shocked I tell you, when the Fed did what they have been telling us for the last month they were going to do: nothing. They left the Fed Funds rate target unchanged, but made it clear by way of their language and the dot plot, the forecasts of individual FOMC members’ forecasts for rates in the future, that this is a pause, not necessarily an end to hikes and certainly not a sign of a policy reversal coming soon to a central bank near you.

Somehow, though, “no change” and “as expected” were seen in this instance as a big shock, and since the announcement yesterday, S&P 500 E-Mini futures (ES) did this:

This seemingly curious reaction is actually perfectly understandable. As I said it would be on Monday, when I previewed the Fed meeting and decision, it is at least as much a product of the market’s positioning and psyche going into the event as it was about the actual result. Traders had convinced themselves that the pause that everyone was expecting would be more than that and had positioned themselves accordingly. Thus, the “expected” outcome of the meeting prompted selling in a classic “buy the rumor, sell the fact” pattern.

What matters going forward is not that technical reaction to the Fed’s decision and commentary, but rather whether it changes the overall mood of the market for an extended period of time. The evidence this morning suggests it will.

For starters, there has been some follow through from that initial drop on the Fed’s news. All three major indices are indicating a lower opening in this morning’s premarket trading as I write this, amid a growing recognition that Jay Powell and his fellow committee members are determined to guide the economy to a landing, even if it isn’t particularly soft. The Nasdaq, comprised primarily of growth-oriented companies, is more sensitive to high interest rates than the Dow, is being hit the hardest of the three, a sign that the extended drop is indeed all about rates. There has been, however, another reaction to news that suggests a more fundamental mood change.

Darden Restaurants (DRI), the parent company of Olive Garden and other restaurant chains, released their earnings before the market opened this morning, and they showed decent results for the last quarter. They beat on the top and bottom lines and left guidance unchanged. However, the stock immediately dropped to a level around four dollars, or more than two percent, below yesterday’s close, indicating an initial negative reaction to news that was objectively neutral to good. That echoes the drop in the broader market to neutral news from the Fed and indicates a pessimism that has been notably absent from the markets for a while.

And there is plenty to worry about if traders are looking for trouble.

We have the escalation of the UAW strike, with 2,000 workers being laid off by GM (GM) and Stellantis (STLA), which won’t help if the economy is being squeezed by higher rates. Then there is the threat of a government shutdown. We have unfortunately become used to that as a tactic in Congress, but this time is a little different. In the past it has been about one party looking to embarrass the other, but this time it is about an internal squabble within the Republican Party. The Democrats will cynically and enthusiastically join the rebels their crusade, making the usual brinkmanship followed by a last minute resolution look less likely than it has been in the past.

There is still some hope. The Bank of England left rates unchanged this morning, as inflation there slowed significantly, reinforcing the fact that higher rates do work to control rising prices. And the market is doing its self-adjusting thing, with oil and other commodity prices falling in response to the Fed announcement, which will relieve inflationary pressure if it proves to be a sustainable move. However, for now, a negative reaction in stocks to the Fed doing as expected and to a good earnings report both indicate a potential change of mood in the market. Together, that makes a cautious approach advisable for a while for investors.

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

Other Topics

Markets Central Banks Economy Investing