Stock Market: Is It Still Broken After the Fed Shock?

Key Concepts

• Federal Reserve (Fed) Policy: The impact of the Fed's interest rate decisions and forward guidance on market sentiment and asset prices.
• Market Reaction to Fed Meeting: The observed market behavior (gapping higher, stalling, selling off) following the Fed's announcement.
• Economic Data and Government Shutdown: The influence of limited data availability due to the government shutdown on market direction and the search for triggers.
• Inflation Expectations: The relationship between inflation expectations, consumer confidence, and monetary policy.
• Asset Performance: Analysis of the performance of major indices (S&P 500, NASDAQ), yields, crude oil, gold, dollar, and Bitcoin.
• ISM Manufacturing and Services Data: Interpretation of Purchasing Managers' Index (PMI) data as indicators of economic contraction or growth.
• Central Bank Policy Expectations: Forecasts for interest rate changes from the RBA and Bank of England.
• Consumer Confidence: The role of consumer sentiment as a driver of economic activity and its correlation with inflation expectations.
• Atlanta Fed GDP Now Model: A tool for forecasting near-term GDP growth.
• Trading Positions: Specific investment strategies and exposures discussed by the speaker.

Did the Fed Break the Stock Market Last Week?

The central question explored is whether the Federal Reserve's recent actions and communications have negatively impacted the stock market. The week leading up to the Fed meeting saw markets gap higher and advance, only to stall on the day of the meeting and subsequently decline. This pattern suggests a potential shift in sentiment or a search for new market drivers.

Last Week's Performance and Market Reaction

• S&P 500: The S&P 500 rose 0.7% net for the week. However, since the Fed meeting, its performance has been less impressive. On Fed day (the 29th), the S&P 500 was down approximately 0.6%. By Friday, it was down as much as 1.14%. Prior to the Fed meeting, it was up about 1.45%.
• Intraday Volatility: On the day immediately following the Fed meeting, the S&P 500 reached a new intraday record high but ultimately closed down nearly a full percentage point (0.97%). This was the largest decline since the significant sell-off in October, where the index fell 2.7%.
• Market Stagnation: Since the Fed meeting, markets have been characterized by a lack of meaningful follow-through in either direction. Buyers have not stepped in aggressively, and sellers have not pushed prices lower.
• NASDAQ Performance: The NASDAQ performed slightly better, rising 1.9% for the week, though this was slower than the prior week. This relative strength was attributed to mostly solid tech earnings, with notable exceptions like Meta's sizable miss and Amazon's strong performance. Apple's earnings were considered neutral due to pre-existing positive sentiment from private sector data on iPhone sales.

The Fed's Communication and Policy Expectations

• Jerome Powell's Statement: Fed Chair Jerome Powell explicitly stated that a December rate cut was "not a foregone conclusion" and emphasized this message.
• Shift in Fed Funds Futures: Prior to the meeting, Fed Funds futures indicated over a 90% chance of a December rate cut. Post-meeting, this probability dropped to just over 60% (67.5%), down from 94.4% a week prior.
• Increased Likelihood of No Change: The probability of rates remaining unchanged in December increased significantly to 32.5%, up from 5.5% the week before.
• Market Calculus Adjustment: This shift in expectations has meaningfully altered the market's calculus and appears to be an inflection point for sentiment.

Broader Asset Class Performance

• Yields: Treasury yields rose, with the 10-year yield up 2% and the 2-year yield up 2.8%. The near-term adjustment was more significant, indicating markets are focusing on the Fed's immediate policy actions.
• Crude Oil: Crude oil moderated after a 7.6% jump. The initial surge was linked to the US placing Russian oil producers (Lukoil and Rosneft) on its entities list, potentially impacting India and China's purchases of Russian crude. The easing was attributed to the story not gaining further traction and a relatively friendly conversation between Trump and Xi.
• Gold: Gold experienced its second consecutive week of losses, down 3.4%.
• Dollar: The US dollar strengthened across the board.
• Euro and Yen: The euro was down 0.9%, and the yen also declined.
• Bitcoin: Bitcoin, often seen as a risk sentiment gauge, showed a divergence by holding up better than stocks, suggesting a potential signal about broader risk-taking that stock markets may not have fully caught up to.

Economic Data and the Government Shutdown

• Limited Data Flow: The ongoing US government shutdown has significantly reduced the availability of macroeconomic data. The release of the US jobs report at the end of the week remained uncertain.
• ISM Manufacturing Data: The Institute of Supply Management (ISM) Manufacturing PMI came in at 48.7, below the expected 49.5, indicating a faster-than-anticipated contraction in the manufacturing sector.
  • New Orders: Shrinking but at a slightly slower rate than the prior month.
  • Employment: Shrinking but at a slightly slower rate.
  • Prices: The price component continued to moderate, showing a cooling pace of price growth in manufacturing, though still elevated compared to historical levels. The speaker noted the potential impact of tariffs on inflation, referencing a surge in prices in early 2025 that could be linked to tariff rollouts.

Fed's Forecast vs. Market Expectations

• Fed's September Forecast: The Fed's September Summary of Economic Projections (SEP) indicated three rate cuts for the year, starting from a 4.4% federal funds rate. However, the majority of Fed officials were skewed towards one or two cuts, with a third cut being an outlier.
• Market Pricing: Markets were only pricing in six basis points of cuts through the rest of the year.
• Disconnect for Next Year: For the following year, markets were pricing in 63 basis points of cuts, which is still in excess of the Fed's projection of a single 25 basis point cut (from 3.6% to 3.4%).
• Significant Adjustment: The Fed's communication led to a significant adjustment in market expectations for the remainder of the year and a slight easing of expectations for the following year, though still expansive relative to the Fed's baseline.

Implications of Policy Shifts and Data

• Stocks Stagnating: As markets adjusted to a less dovish outlook, stocks stopped advancing and entered a range-bound period.
• Dollar Strengthening: The dollar continued to push higher as dovish signaling was removed from the table.
• ISM Services Report: The upcoming ISM Services report (expected on Wednesday) is crucial. Expectations are for a slight pickup to 50.7 from a standstill in September.
  • Price Component: The price component of the services ISM is particularly important as it tends to lead CPI and PCE inflation measures by 2-3 months. A potential inflationary pickup in the services sector could justify the Fed's downplaying of easing.
  • Anti-Risk Adjustment: If the market continues to see a shift towards a more inflationary setting and less Fed stimulus, it could lead to a further de-risking and an anti-risk adjustment (lower stocks, higher dollar).

Other Policy Announcements and Data

• RBA (Reserve Bank of Australia): Expected to keep rates unchanged due to slightly cheaper inflation data.
• Bank of England: Also expected to hold rates unchanged, with inflation stabilizing at a relatively high level. The voting tally is anticipated to be 6-3 in favor of a standstill.
• Chinese Trade Data: Expected on Friday, potentially impacting trade war sentiment.
• University of Michigan Consumer Confidence Survey: In the absence of a jobs report, this survey serves as a private sector proxy for official data.
  • Deteriorating Sentiment: The headline sentiment reading is expected to decline from 53.6 to 53.2, indicating a further deterioration in consumer confidence.
  • Inflation Expectations vs. Confidence: Historically, consumer confidence has declined as inflation expectations rise. While inflation expectations have cooled, consumer confidence has not significantly improved and has returned to levels seen during the tariff scare.
  • Impact on Consumption: A significant decline in consumer confidence, which drives 68% of household consumption, could pose a risk to the economy.

Economic Outlook and Potential Risks

• Atlanta Fed GDP Now Model: The model has shown an improving tone for economic data since early August, with the blue-chip consensus revised higher, suggesting an accelerating economy.
• Conflicting Scenarios:
  • If the economy is accelerating, the Fed has less room to cut, which markets may not like.
  • If the economy is not accelerating, the Fed may be reluctant to cut due to a lack of aggregate data, leading to disappointment for markets expecting stimulus.
• Potential Sentiment Risk: Regardless of the scenario, there appears to be a potential risk to market sentiment.

Speaker's Trading Exposure

The speaker outlines their current trading positions:

• Long the Dollar.
• Short the Aussie, Pound, and Euro. (Increased short euro position).
• Short Gold (via short call vertical and futures).
• Short Bitcoin (via ETF put vertical).
• Short Risk (via SPY put verticals).
• Long the long end of the bond market (TLT call verticals, acknowledging it's going the wrong way).
• Short Crude Oil (moderating after a prior surge).

The speaker concludes that Macro Money will return tomorrow, and encourages viewers to like and subscribe on YouTube.