Stocks After Fed Shock: Do Markets Still Care About Tech and China?

Key Concepts

Hawkish Fed Outlook: The Federal Reserve signaling a less dovish stance, potentially delaying or reducing expected interest rate cuts.
Market Indigestion: The negative reaction of financial markets to unexpected or hawkish monetary policy signals.
Yield-Sensitive Yen: The Japanese Yen's tendency to weaken when US Treasury yields rise.
ECB Monetary Policy: The European Central Bank's decision to hold interest rates steady, signaling no imminent cuts.
Risk Aversion: A market sentiment characterized by investors moving away from riskier assets towards safer ones.
Gold as an Alternative Asset: Gold's role as a hedge against inflation and currency devaluation, but vulnerable to rising yields and a strong dollar.
FOMC Policy Announcement: The Federal Open Market Committee's official statement on monetary policy.
Fed Funds Futures/ESTR Interest Rate Futures: Financial instruments used to speculate on future interest rate movements.
Dot Plot: A graphical representation of FOMC members' individual projections for the federal funds rate.
Basis Points (bps): A unit of measure equal to one-hundredth of a percent (0.01%).
PMI (Purchasing Managers' Index): An economic indicator that measures the manufacturing and services sectors' health.
ISM Manufacturing and Services Reports: Key economic reports tracking the performance of the manufacturing and services sectors.
Atlanta Fed GDP Now Model: A real-time forecasting model for US GDP growth.
Short Call Vertical: An options trading strategy that profits from a decline in an asset's price.
SPY Put Verticals: An options strategy used to bet on a decline in the S&P 500 index.
TLT (iShares 20+ Year Treasury Bond ETF): An ETF that tracks long-term US Treasury bonds.

Fed's Hawkish Shift and Market Reaction

The past 48 hours have been dominated by the Federal Reserve's unexpectedly hawkish outlook, which has caused significant "indigestion" in the markets. This hawkish shift has led to a broad market sell-off, with the S&P 500 down nearly 1% and the NASDAQ down almost 1.5%. Bond yields have risen, and the US dollar has strengthened across the board, particularly against the yield-sensitive Japanese Yen.

Key Points:

Fed's Shocking Outlook: The market had priced in a December rate cut as a "foregone conclusion," with over a 90% probability. However, Fed Chair Powell's statements indicated that a December cut is "not a foregone conclusion. Far from it."
Shift in Rate Cut Expectations: The Fed Watch tool now shows a significantly increased likelihood of rates remaining unchanged and a decreased probability of an additional cut. This shift is a direct consequence of Powell's remarks.
September Projections vs. Current Outlook: In September, the Fed's median projection for the Fed funds rate was 3.6%, implying three 25 basis point cuts. The market had also anticipated three cuts. The current sentiment suggests a debate within the committee, with a more hawkish leaning.
"Risk Management Cuts": Powell characterized the September and October rate cuts as "risk management cuts," implying that future decisions will be more data-dependent and less about managing perceived risks.
Economic Data as a Driver: Powell highlighted that data before the government shutdown indicated a firmer economy. Recent S&P Global PMI numbers showed growth levels similar to multi-year highs in the second half of 2024. This accelerating economy reduces the scope for rate cuts.
Fed's Increased Projections: The Fed's own forecasts have increased economic growth projections, raised inflation expectations, and decreased bets on the unemployment rate, further supporting a less dovish stance.

Market Price Action and Anomalies

The market's reaction has been characterized by a broad sell-off, but with some interesting divergences.

Key Observations:

Stocks Follow Through: While initial reactions to the Fed announcement saw stocks relatively neutral, they decided to follow through with a sell-off on the subsequent day. This occurred despite positive earnings from Microsoft and Google, and a significant miss from Meta.
Gold's Unusual Rally: Gold has surprisingly perked up despite rising yields and a strengthening dollar. Typically, rising yields and a strong dollar are detrimental to gold, as it offers no yield and is an alternative to fiat currencies. This disconnect is a significant point of interest.
Bitcoin's Decline: Bitcoin has been heavily impacted by the generalized risk aversion, falling nearly 4%. This follows the pattern of "stocks or risky assets on steroids," where Bitcoin sells off more when Wall Street declines.
Dollar Strength: The dollar has continued to rise, supported by a more favorable yield architecture. Interestingly, the dollar has been on an upward trend since July, irrespective of dovish or hawkish Fed signals.

Upcoming Economic Data and Inflection Points

The focus now shifts to upcoming economic data, which will be crucial in determining the future path of interest rates and market direction.

Key Data Points:

ISM Manufacturing and Services Reports: These reports, due next week, are critical. The manufacturing report is scheduled for Monday.
- Scenario 1 (Standstill): If the ISM reports mirror the S&P Global PMIs, showing the economy at a standstill (around 50), it could provide more room for rate cuts.
- Scenario 2 (Acceleration): If the ISM reports indicate economic acceleration, as hinted by the Fed chair and S&P Global PMIs, it would further limit the scope for easing and potentially extend the current downside in markets.
Atlanta Fed GDP Now Model: This model has consistently shown data biased towards stronger growth, with consensus forecasts improving to between 2-3% annualized growth. This reinforces the idea of a potentially accelerating economy.

Positioning and Strategy

The speaker outlines their current trading positions based on the prevailing market conditions.

Current Positions:

Short Gold: The speaker is short gold, expecting the recent bounce to fizzle out. They believe the rally is corrective and the trend remains downward.
Long Dollar: They are maintaining a long dollar position against the Australian Dollar, Pound, Euro, and Canadian Dollar.
Short Risk (Bitcoin): Exposure is short risk via a Bitcoin ETF.
Short S&P 500: Put verticals on the S&P 500 (SPY) were initiated after Powell's remarks.
Long Bonds (Long End): While acknowledging bonds as a loser, the speaker is long the long end of the curve (e.g., TLT), believing that rate cuts will simply be pushed further down the timeline.
Short Crude Oil: A short position in crude oil is maintained, as geopolitical tensions around Lukoil and Rosneft appear to have fizzled out.

Conclusion and Takeaways

The Fed's hawkish pivot has fundamentally altered market expectations for interest rate cuts. The market is now grappling with the implications of a potentially stronger economy, which reduces the need for aggressive easing. Upcoming economic data, particularly the ISM reports, will be critical in confirming this trend and will likely dictate the next significant market move. The unusual strength in gold despite rising yields and dollar remains a key anomaly to watch. The speaker's positioning reflects a cautious approach, betting on continued dollar strength, a decline in gold, and a potential further downside in equities, while favoring the long end of the bond market.