S&P 500 Biggest Rally in 2 Years After the Biggest Fed Hike in 22 Years – Why?

[embedded content]

S&P 500, Dollar, Fed Decision and GBPUSD Talking Points

  • The Trade Perspective: S&P 500 Bearish Below 4,100 After FOMC; USDJPY Bearish Below 129; GBPAUD Bullish Above 1.79
  • The Federal Reserve announced a 50bp increase to the Fed Funds range to 0.75- 1.00 percent and a starting QT of $45.7bln per month to a max of $95bln in 3 months
  • Despite the hawkish implications of this move, the market was pricing in a 75bp hike come June 15 which Powell played down, leading SPX to rally and Dollar drop short-term

The FOMC Was Unmistakably Hawkish

You may not have been able to interpret it from the market’s response – a sharp S&P 500 rally and a slide from the US Dollar – but the Federal Reserve’s monetary policy mix this past session was unmistakably hawkish. At the close of the two day meeting, the central bank rates its benchmark lending rate by 50 basis points to a range of 0.75 – 1.00 percent. This may be the second rate hike in the cycle after the March 16h increase, but we haven’t seen a half-a-percent jump to the overnight since May of 2000. That is a market acceleration. Adding to the hawkish overview, the Fed announced that it would start reducing its massive $8.94 trillion balance sheet starting on June 1st at a $47.5 billion clip and then accelerate to $95 billion per month starting in September. Further, to further the message that we have heard in previous weeks that this is a committed program to bring down inflation such that market tantrums wouldn’t throw the effort off course, Chairman Jerome Powell started his presser with an explicit focus on inflation and said that “50 basis points should be on the table for the next couple of meetings.” The caveat for the speculatively inclined was the reply to a journalist question that a 75 basis point rate hike was not under discussion. If you were watching Fed Fund futures, you would have seen that speculation of just such an aggressive move next month (June 15th) stood around a 90 percent probability.

Scenario Table for May 4th FOMC Rate Decision

Chart Created by John Kicklighter

The Markets Response: Short-Term and Long-Term

Was there room for a relief rally form capital markets following an otherwise very hawkish central bank rate decision? Apparently so. Given the short-term forecasts that futures markets were pricing, there was a necessary adjustment that would filter through the market – down to the more traditional risk assets. That said, if the consistency that was suggested previously is combined with Powell’s suggested tempo (two meetings of 50bp and the remaining decisions presumably 25bp clips), the Fed’s rate range should end the year at 3.00-3.25 percent – in-line with what swaps have projected through the close of 2022. So, while there may be some adjustment that needs to be done in short-term pricing, it is more likely that a habitual speculative opportunism kicked Wednesday after the remarks hit the wires.

Chart of S&P 500 Overlaid with the Implied Rate Forecast for June 15 via Fed Fund Futures (Daily)

Chart Created on Tradingview Platform

Just because the market’s reaction to the high-profile event risk this past session seems to defy the lasting fundamental gravity, that doesn’t mean that the move wasn’t impressive. While the charge in risk appetite was wide, the S&P 500 takes the prize for relative tempo. One of the most recognizable market measures, the SPX posted a rally that was just shy of a 3.0 percent single-day climb. That is the biggest rally in percentage terms since May 18th, 2020. The question now is how quickly this upswing runs out of momentum. There are a host of technical resistance levels above – the 4,308 swing high on April 28th; the 4,337 ‘technical correction’ tipping point 4,380 range low through mid-April – but I’m more concerned about momentum that the weight of technical boundaries.

Chart of S&P 500 with 1-Day Rate of Change (Daily)

Chart Created on Tradingview Platform

Market Sentiment Looking Beyond the ‘Buy the Dip’ Blackout

For those with a bullish bias that aren’t simply looking for the binary response to the Fed decision, follow through is a necessary feature to draw in more interest behind the earlier movers. I find that a difficult view to justify. While we have seen commitment to traditional fundamental values suspended many times in the past decade, it is growing increasingly difficult to default to denial. With the US central bank confirming an aggressive tightening regime ahead, the cost of rampant speculative exposure will grow more abruptly. The lack of gains will grow increasingly apparent – moreso than the erosion of real returns undermined by oppressive inflation. I asked traders in a Twitter poll what they expected from the Fed moving forward. The initial breakout of responses showed 28 percent expected the rally to extend over the coming two weeks, 19 percent believed the S&P 500 would level out and 53 percent said the bearish pressures would kick back in.

Poll Asking Whether the S&P 500’s Rally Continues, Stalls or Reverses in Two Weeks

Poll from Twitter.com, @JohnKicklighter

Not everything in the wake of the Fed decision will be registered in risk trends. Just as remarkable – and walking the line of short-term reaction and long-term implications – was the Dollar’s slide after Powell’s comments. It is important to highlight when the market actually started to move. There was little movement from the Greenback after the news of the 50bp hike and the statement’s laying out the balance sheet runoff. It wasn’t until the Chairman’s remarks started to hit the wires that the currency started to move. When the 75bp speculation was officially squashed, the DXY Dollar Index slipped below the past week’s range floor. The move was not particularly aggressive, but it is nevertheless provocative on a technical basis. I believe the same perspective we discussed with the S&P 500 above applies to the Dollar – but there is even more substantial curb against the reversal. A 50bp hike this month and 3.00 percent benchmark rate projected through year end contrasts significantly to the forecast for the USD’s most liquid counterparts: 0.7 percent for the Euro via the ECB and -0.1 percent for the Yen through the BOJ’s vows.

Chart of USDJPY Overlaid with US-Japan 2-Year Yield Spread, 20-Day Correlation (Daily)

Chart Created on Tradingview Platform

What’s Immediately Ahead

First and foremost on my list to watch in the markets is to see how far the counterintuitive momentum for US indices and the Dollar post-FOMC persists. That said, there is plenty in the way of additional event risk and theme that should be digested for market moving potential. Sticking with the Greenback for a moment, this past session’s ISM service sector miss was noticeably downplayed – including a drop in the employment component that actually tipped it into negative territory (service sector jobs account for the vast majority of employment in the US). That should add weight to Friday’s NFPs. In the more immediate foreground, I will be watching the Bank of England rate decision due at 11:00 GMT. The economist forecast is for a 25bp increase to 1.00 percent, but markets have – at least up until the Fed fallout – debated a 50bp move quite heavily. If the market is in a mood to be disappointed, beware for the Sterling.

Calendar of Major Economic Events

Calendar Created by John Kicklighter

While a 25bp hike from the Bank of England would be a tepid clip relative to the Fed, RBNZ and Bank of Canada; it would still be a hawkish move for a group that has already move three times in this cycle. Despite the rate speculation, the Sterling has drifted lower these past weeks, which may add to its potential to move should the MPC ‘beat expectations’. Pairs like EURGBP better highlight the rate forecast contrast while GBPJPY cam generate amplitude through the ‘risk’ connection, but I am also enamored with EURCAD. The Loonie earned its gains through the two rate hikes realized thus far – including the 50bp move back in April. That said, there is so limited a speculation for the Sterling via GBPCAD, that I will be watching its technical guidelines.

Chart of GBPCAD with 20-Day SMA (Daily)

Chart Created on Tradingview Platform