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75% of retail investor accounts lose money when trading CFDs with this provider.

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Market Insights

Fed stays hawkish - Stock market selloff just getting started?

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The Fed remained hawkish at the policy meeting on Wednesday, hiking by 0.5% to 4.5%. The story now seems to have flipped from inflation to growth concerns. Stocks are selling off and the market pricing of interest rates has diverged from the Fed forecasts.

Let’s take a look at the S&P 500 chart

image

Looking very much like a strong bear market rally may have come to an end at the convergence of the trendline and 200 day moving average. Anything can happen from here, but it’s hard to interpret the recent price action as bullish.

Why did the stock market react negatively to the Fed meeting?

There are plenty of reasons to point to. The dot plot being one of the main suspects. See the chart below:

HawkishDots

At first glance, it might not make much sense. All the dot plot shows is Fed members best guesses of where interest rates will be at the end of 2023.

The chart shows how this has progressively evolved to higher levels since 2020, and as we head into 2023, the Fed sees interest rates on hold slightly above 5% throughout the year. Chair Powell highlighted this in the press conference:

“I wouldn’t see us considering rate cuts until the committee is confident that inflation is moving down to 2% in a sustained way… Restoring price stability will likely require maintaining a restrictive policy stance for some time”

Why would this matter for stocks? Aside from the increase in financing costs, it also increases the ‘risk free rate’, making stocks less appealing relative to other instruments, such as government bonds.

If an investor is faced with the choice of backing a plucky startup with low odds of success (but a high payoff if they pull it off) or parking their cash in government bond money market funds, the yield is a big factor in that decision. If cash is yielding 5%, why take that risk?

It’s said that assets are usually priced relative to each other, so in the post GFC world of very low interest rates, stocks and riskier investments tended to outperform as asset managers were forced to take higher risks to meet their return benchmarks.

Howard Marks wrote an excellent note on this phenomenon titled Sea Change:

In the low-return world of just one year ago, high yield bonds offered yields of 4-5%. A lot of issuance was at yields in the 3s, and at least one new bond came to the market with a “handle” of 2. The usefulness of these bonds for institutions needing returns of 6 or 7% was quite limited.

Today these securities yield roughly 8%, meaning even after allowing for some defaults, they’re likely to deliver equity-like returns, sourced from contractual cash flows on public securities. Credit instruments of all kinds are potentially poised to deliver performance that can help investors accomplish their goals.

Then consider the rest of the Fed’s projections. Slower economic (GDP) growth of just 0.5% in 2023, and an increase in the unemployment rate to 4.6% (compared to 3.7% in November).

A slowing economy and higher interest rates could be a tough environment for the S&P 500. However, the market doesn’t agree with the Fed’s forecasts, and is pricing rate cuts for the second half of 2023, presumably due to a sharper than expected fall in inflation and economic slowdown.

Not investment advice. Past performance does not guarantee or predict future performance.

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This page/website is not directed to EU clients and falls outside the European regulatory framework and is not in the scope of (among others) the Markets in Financial Instruments Directive (MiFID) II.
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Important notice

This page/website is not directed to EU clients and falls outside the European regulatory framework and is not in the scope of (among others) the Markets in Financial Instruments Directive (MiFID) II.
By continuing you acknowledge to view the content provided by Skilling (Seychelles) Limited, which is authorised and regulated by Seychelles Financial Supervisory Authority, and that your decision was made independently and at your exclusive initiative and no solicitation or recommendation has been made by Skilling or any other entity within the group.

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