It’s not just about the Fed

Mid-week market update: The market reaction to the FOMC decision was mostly a yawn. The Fed raised rates by a quarter-point, which was expected, and Powell refused to commit to further hikes while repeating his data dependency mantra.  As a consequence, the S&P 500 was mostly unchanged from before the decision to after the close. However, the 2-year Treasury yield, which is a proxy for Fed Funds expectations, did ease a little. Fed Funds expectations were mostly unchanged, other than the first easing was pulled from the May 2024 FOMC meeting to March.

How the stock and bond market disagree

The stock and bond markets have been in disagreement. While the S&P 500 has moved steadily upward in the past few weeks, which indicates growing optimism about a soft landing, the bond market has been range-bound, indicating continuing concerns over inflation, the growth outlook, and Fed policy. Even as technicians analyze charts to discern the message of the market, the stock and bond market disagreement will be a source of risk and volatility. One source of near-term risk is the negative 5-day RSI divergence exhibited by the S&P 500 as it advanced.

 

 

Sources of volatility

We are proceeding through Q3 earnings season, with a number of prominent heavyweights reporting this week. Be prepared for choppiness as individual companies report results.

From a broader perspective, I continue to be concerned about the odds of a slowdown. The signs of a slowdown are beginning to be seen in a deterioration in forward 12-month margins.

 

Looking ahead, we have interest rate decisions from the ECB and the BOJ this week. As well, investors will see an update to the inflation picture from PCE, which is the Fed’s preferred inflation metric, and the quarterly Employment Cost Index, which measures total compensation. While Fed Chair Powell declined to comment on any single union contract, the Fed is likely to see the recent UPS-Teamsters agreement as an indication of continuing strong wage pressures. In addition, gasoline prices have been rising, which will put upward pressure on headline inflation.

Bottom line, the stock market is being buffeted by many sources of volatility while equities are priced for a soft landing. This represents a condition that’s makes equities vulnerable to a correction in the short run. Longer-term, the outlook depends on whether you are in the soft landing camp or the recession camp.