The market is fighting the Fed, should you?

Posted by Cam Hui - June 12, 2024

Mid-week market update: The option market was pricing in a daily equity market swing of 1.6% ahead of today’s events, namely the May CPI report and the FOMC decision. Even though the S&P 500 gained strongly today, the move could be said to be disappointing in volatility terms.

The bullish tone was set this morning by the softer than expected CPI report. Stocks gained but didn’t react much to the FOMC decision, despite the hawkish tone of the Summary of Economic Projections. Bond prices held above a key resistance level, and the USD weakened, indicating a risk-on tone.

The market is fighting the Fed, should you?

A soft inflation report

The May CPI report was much softer than expected. May core CPI (blue bars) came in at 0.16%, which was cooler than the forecast consensus of 0.3%. Supercore services (red bars) was also weak. These are all welcome signs of moderating inflation readings. The one caveat is this is only one data point and don’t necessarily represent a sufficient trend for the Fed to be confident about cutting rates.

As I’ve pointed out before, the Citi Inflation Surprise Index has been coming down for most major economies. It was therefore no surprise that other central banks, such as Switzerland, Sweden, the ECB, and Canada, have initiated rate cut cycles.

How the Fed is different

In many ways, the U.S. is different and it has shown an unusual degree of strength when compared to other economies. The Fed’s Summary of Economic Projections (SEP) published today contained several hawkish surprises.

Upward revisions in the dot plot of year-end Fed Funds projections;
Expected rate cuts reduced from three to one;
An upward revision to the long-term Fed Funds equilibrium rate.

Fed Chair Powell was asked during the press conference a number of questions that he tried very hard not to answer. The projected 2024 GDP growth rate and the unemployment rate are unchanged from March, why did the inflation forecast rise? Can you reconcile the median projection of one rate cut of one this year against no projected changes in growth or unemployment?

What Powell couldn’t say was the “dot plot” showed four participants are projecting no rate cuts in 2024. There is a significant minority of hawks in the FOMC who are adamant against rate cuts. Powell has a problem of cutting rates before the election without the move being politically motivated. He can’t afford to have any dissents. Nevertheless, the market is expecting two rate cuts this year. One in September and one in December.

I think that the market is likely to be disappointed in light of Powell’s political bind.

A vulnerable stock market

This leaves the stock market vulnerable to a short-term setback. The S&P 500 spiked above its upper Bollinger Band in the wake of this morning’s CPI print. In the past, such events have been followed either by an upper Bollinger Band ride or the sideways consolidation of a few days before making the next tactical directional move. What’s different this time compared to past upper BB spikes is relative breadth is narrowing.

It’s not unusual to see directional market moves on FOMC decision day reverse themselves the next day. Tomorrow’s PPI report could be a negative catalyst. While I am not an advocate for shorting this market, you should also be aware that stocks can pull back at any time.

1 thought on “The market is fighting the Fed, should you?”

Gordon says:

June 12, 2024 at 5:09 pm

While on a relative basis the SPXEW (or RSP) vs SPX doesn’t look too good I note that on an absolute basis the RSP has been going sideways since 23rd May. Maybe this will develop into a support level for the broader market.

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