Central Banks

Week Ahead: Fed, Fed, Fed!

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

Stop me if you’ve heard this one before, but this week, the stock market will be focused on the Fed. Hardly breaking news, I know. Let’s face it, traders and investors have been almost entirely focused on the Fed for around two years. Every data release, every macroeconomic news headline, and every rumor during that time has been seen through one filter only: what impact will it have on the Fed’s rate decisions? Early on in the saga, when we still believed that recession was certain to follow rate hikes, that made sense.

At this point, however, after seeing continued growth in the economy despite the Fed Funds rate climbing from zero to above five percent and the S&P 500 posting year-to-date gains of over sixteen percent as a result, it is clear that what were previously considered simple rules of economics don’t apply in the current situation.

So why all the fuss every month when the FOMC meets? Why will everything stop on Wednesday? Why are we concerned about a rate decision that just about the entire market believes will be “no change,” and which one could even argue won’t have a big effect on the economy? Even though the market feels that they know what's coming, there are two main reasons why everyone will be waiting with bated breath for the words of Fed Chair Jerome Powell.

The first is that even though everyone believes that there will be no change to the Fed Funds rate this time around, there is some disagreement as to why that may be. Is it a pre-planned pause, prompted by the reasonable belief that the impact of rate hikes takes time to be felt? If so, then it really has no bearing on what will happen the rest of this year, or into 2024. The Fed has already made up their mind to wait and see in that case.

Or is it a response to what the Fed sees as some weaker economic data? Does the FOMC believe that they have already achieved their stated goal of slowing the economy enough to have a permanent handle on inflation? If that is so, then what we will get on Wednesday will be interpreted as more than just a pause. It will be seen as an indication that rate hikes are over, and the only thing left to decide is when to start cutting.

That uncertainty over their motive is inevitably tied to the second reason for the eager anticipation of Wednesday’s decision and comments: What will it tell us about the Fed’s intentions going forward? The reading of the tea leaves will range from the obscure -- a detailed parsing of the words in the accompanying statement -- to the blatant and obvious -- the “dot plot” that indicates where FOMC members think rates will be in the future. The market reaction on Wednesday is expected to be based on those things, not necessarily the decision itself.

There are, however, two problems with that from a trading (short-term) and investing (long-term) perspective. From a trading perspective, whenever everyone agrees on anything, risk/reward gets skewed to the point where taking a contrarian position, even if you can logically find no reason to do so, makes sense. If everyone is long going in, expecting no rate hike, then who is left to buy should that be the case? Even if there are a few late-to-the-party buyers left, there will be no shortage of sellers looking to take a quick profit on their long position.

So, the upside is limited. The downside, on the other hand, is big. If the Fed should decide for whatever reason to actually hike a quarter point this month, the rush to exit the long positions will be spectacular. To be clear, I am not saying that this is what will happen, just that taking a long position in index futures or whatever into the release makes no sense, whereas doing the opposite offers exaggerated profit potential potential, but reduced risk.

The second problem is more from a longer-term investing perspective. So far, the numbers suggest that the Fed has done an excellent job of getting a handle on inflation while not really damaging the economy and causing any pain. However, the history of how they got there doesn’t exactly inspire confidence that what they say they will do is, at any time, predictive. Remember, this is the same Fed Chair that gave us the word “transient” and, to be a little kinder, Powell has said on numerous occasions that the FOMC’s decisions will be data dependent.

That is a polite way of saying that not even they know what they will do in the future.

This week will, like so many weeks over the last couple of years, be all about the Fed. What makes this week different is that this time, everyone believes they know what is coming. That may make anticipation of the decision seem a bit pointless, but it does create some opportunities for those, like me, who believe that the market psyche and collective positioning is often more important than the more material and better known drivers of stock prices.

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.

Read Martin's Bio