A Deep Dive Into The Latest FOMC Day

At its apex yesterday, the Dow (DJI) was up some 350+ points. All major averages were up greater than 1% going into the 2:00 p.m. EST FOMC rate hike announcement. By and large, market participants were expecting/anticipating a dovish Fed rate hike. By and large, that’s what they got. The problem then, as the major averages gave up all their gains and fell nearly 2% after the .25 bps rate hike announcement, was that the Fed wasn’t dovish enough. Market expectations were simply too dovish and set the Fed up for disappointment. But the fault doesn’t lay completely with market participants. We can certainly find fault in the Fed’s messaging and failure to guide market expectations, as former Fed leaders have been able to do. The messaging problem from this FOMC regime, led by Fed Chairman Jerome Powell can be no better identified than in the following chart by Bespoke Investment.

As shown in the chart above, we've now had 7 Fed Days under Chairman Jerome Powell, and the S&P has fallen on all 7 Fed Days. Next longest losing streak was just 4, back in 2002. As stated previously, the Fed’s revised rate hike path tilted more dovish, but not enough and not to the degree the market expected. Messaging fills the gap between market expectations and the Fed’s rate hike/balance sheet forecast. The market has clearly stated the Fed’s messaging by Chairman Powell has been poor.

So what did the Fed deliver to the market by way of its .25 bps rate hike and press conference speech? Firstly, below are the changes offered in the Fed’s statement.

“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects judges that some further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective over the medium term. Risks The Committee judges that risks to the economic outlook appear are roughly balanced, but will continue to monitor global economic and financial developments and assess their implications for the economic outlook.”

Prior to the most recent FOMC rate hike and press conference, the Fed’s dot plot forecasted 3 rate hikes were probable for 2019. Based on weakening global economic activity, weakening PCE data and declines in interest rate sensitive industries (housing and autos), the Fed acknowledged the variables and reduced their rate hike forecast from 3 hikes in 2019 down to 2 rate hikes. The market was expecting the FOMC to forecast only 1 rate hike, at best, for 2019. The Fed was dovish, but not dovish enough given the market expectations.

Moreover and where the equity market really started to unravel was when Fed Chairman Powell stated the Fed was satisfied with its program to reduce the balance sheet and it has no plan to change it. This statement was akin to Chairman Powell’s perceived autopilot statement surrounding future rate hikes from the September FOMC meeting. So while expressing data dependency for future rate hikes, the lacking of flexibility regarding the balance sheet’s monthly run-off of some $50bn in Treasuries proved the undoing of the market on Fed Day. 

“Powell said he sees no problem with balance sheet runoff. That’s the one that hurts,” said James Paulsen, chief market strategist at Leuthold Group. “That’s another potential path of dovishness that he didn’t take.”

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Gary Anderson 3 months ago Contributor's comment

Fascinating article. We know the Fed was too tight leading up to the Great Recession, a decade ago. It clearly is trying for a softer landing this time. Pushing the stock market down a little is likely preferable to what happened in the Great Recession. We are back to the exact same things to look for as back then, possible credit unavailability due to speculation failures and NGDP measurements. Inflation is not as important as those two. In the Great Depression, inflation rolled on for months while NGDP was cratering.