The obvious thing to concentrate on this week is the meeting of the Fed’s Open Market Committee (FOMC) and the subsequent release of their decision on Wednesday. Actually, the decision itself is a foregone conclusion, it is the forecasts, the so-called “dot plot” and the wording of the committee’s statement, that look likely to have a major impact on the market, whichever way it goes.
To this point, Jerome Powell’s Fed, like so many in the post-Greenspan era, has been mostly remarkable for its ability to be unremarkable. They have continued along a path of easy monetary policy, while presenting that as not just uncontroversial, but also destined to continue for several more years. As the data indicating quite significant inflation in America have piled up, they have managed to continue on that path by labeling the price rises "transitory." The logic behind that theory, that the pandemic resulted in unprecedented supply chain disruption and therefore higher input prices, is irrefutable, but the further into the recovery we go and the more reports there are that show prices, and as a result wages, are rising, the less believable it becomes.
Whether transitory or not, the March CPI numbers leave the FOMC with a problem. After the five percent jump shown in that report, consumer prices would have to actually fall throughout the rest of this year for annual inflation to be at the committee’s March forecasts, and with many companies only recently starting to pass their increased costs onto consumers, that isn’t about to happen. Add in what seems to be a persistent labor shortage and increased upward pressure on wages looks sure to follow, closing the vicious circle that marks a classic inflationary environment that is anything but transitory.
For a Fed that has shown itself to be somewhat sensitive to the market reaction to their decisions and utterances, as this one has, that presents a major problem. The obvious thing to do is to recognize what is going on and take action to reverse the trend early, either by hiking rates or reducing and ending bond purchases. Anyone who believes that the Fed will actually raise rates or end QE at this meeting, though, is, to put it charitably, slightly off in their perception of what's to come.
That isn’t going to happen. What the Fed might do is to signal on the dot plot an expectation that there will be a rate hike next year, or even as soon as later this year. If they do that, however, based on taper tantrums in the past, the market won’t take it well. I am not the only person who has been pointing out for some time that even though the recovery from the pandemic has been rapid and strong, and with current stock market levels way above the pre-pandemic highs, this can only be justified by low rates and the expectation of maintaining the six or seven percent growth that we are seeing now. If rate hikes are signaled, those expectations disappear, and asset prices will have to adjust.
If, on the other hand, the Fed says, "nothing to see here," and indicates that they will continue to see this as a small blip on the long-term curve, there will be much rejoicing among traders, and lo, new record highs will once again be daily occurrences for a while.
The delta between those two possible outcomes is massive, but there is a third potential result of this week’s meeting and, based on what we have seen recently, it may be the most likely. The FOMC could agree to change little or nothing about the dot plot or their official view but make a few subtle tweaks to the wording of their statement that indicate that change is coming soon. The problem is that, while that tactic has worked to appease both sides of the inflation debate up until now, we are past the point where it will continue to do so. It will be seen by those scared of tighter monetary policy as a sign that that is coming, and by those scared of inflation as too little, too late. Either way, stocks get hit.
So, while "waiting for the Fed" seems to be an all-too-frequent commentary on the market these days, it is completely understandable this week and, until we know more on Wednesday afternoon, traders and investors should avoid doing anything drastic.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Martin Tillier
Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.
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