Could A ‘Fed Pause’ Be On The Table?
2022.05.31 17:45
This year, the Federal Reserve has done a good job of convincing market participants that the infamous ‘Fed put’ is firmly off the table. However, we could be seeing the first signs of a possible ‘Fed pause’ on the horizon.
The risk-off mood has temporarily cooled, and US stocks have been bouncing back as the market digests Wednesday’s release of the minutes from May’s FOMC meeting. The minutes discuss a potential pause in rate hikes after two 50-basis-point rises in June and July.
Atlanta Fed President Raphael Bostic had already commented on the same effect before the release of the FOMC meeting minutes; the rationale behind the suggestion was that it would allow the Federal Reserve to monitor the effects rate hikes have on the US economy.
Price Action
The Russell 2000 led the major US indices, surging 2.25% on the day. It then gapped up on Thursday’s open and rallied a further 1.5%. The NASDAQ rose by around 1.9% on Wednesday and rallied over 3% during Thursday’s session. The S&P 500 rose by 1.25% on Wednesday, and a further 1.8% on Thursday, taking it just above the 20-day moving average for the first time since early April.
S&P 500, Russell 2000 and NASDAQ daily charts.
The Russell 2000 and Dow Jones Industrial Average have currently made the most convincing breaks above their respective 20-day moving averages, with the NASDAQ yet to clear this line.
Sector-wise, we’ve seen home construction, consumer discretionary, metals and mining, financials, and technology outperforming. The most intriguing of these have been the bounces in home construction and financials. The latter has convincingly broken above its 20-day moving average, and home construction is currently trading above both its 20-day and 50-day moving averages.
US sector-wise daily charts.
While this subtle change in tone may have temporarily brought risk appetites back, it’s important to consider how much has changed since that last meeting. A subject all FOMC members agreed on a few weeks ago was the health of the US economy and the tightness of the US labor market. Since that meeting, we’ve had a slew of disappointing economic data from housing, labor, and sentiment surveys pointing to a general slowdown of the US economy.
While inflation is still front and center, both for the Federal Reserve and the presiding government (particularly in a midterm election year), this recent shift in tone suggests that the Fed may not be so willing to push the economy into recession to get inflation down, as it would have had the market believed just a few weeks ago. It may just be that the Fed’s overly hawkish rhetoric has done enough to tighten financial conditions before the coming hikes and the official commencement of quantitative tightening on Jun. 1.
Fed Managing Expectations
In this respect, the Fed is playing a very delicate game of managing expectations, as well as carefully trying to take the air out of certain corners of an economy that have become wildly overheated since the pandemic response.
An interesting line in the sand that recent price action has respected is the 3800 level on the S&P 500, which coincides with a more than 20% drop from its November peak. This is also the accepted definition of a bear market, and this recent bounce has led to the S&P 500 narrowly escaping it, for now. The Russell and NASDAQ have been in bear markets since earlier this year.
Traders Should Be Wary
From a trader’s perspective, sentiment has been overwhelmingly one-sided and the risk-off mood so pervasive that at some point, you have to start questioning whether investors have over-corrected, leaving open the possibility for rallies such as the one we’re witnessing to extend further.
However, this price action doesn’t change the underlying fundamentals, which remain bearish. This may be the kind of volatility that traders crave, but it’s important to remember what kind of market you’re trading in. Lower highs ought to be respected as potential sell zones, and stops should be well-managed in this current one.
