Don't Fight The Fed

On February 1st, the Federal Open Market Committee (FOMC) meeting minutes were released, and the Fed announced a 25bps rate hike. As such, markets started to rally.

An interesting note is that the FOMC meeting minutes and the associated press conference appeared contradictory in nature because there was not a straightforward hawkish or dovish narrative across both. The statement was hawkish. Meanwhile, Fed Chairman Powell’s language in the press conference was remarkably dovish, describing the disinflation process as having started and as “encouraging and gratifying”. This was seen by markets as the signal to continue the recent rally. Precious metals, equities, and risk assets have all seen significant post-meeting relief.

The first innings of a recession always appear to be somewhat of a soft landing in which inflation and growth begin to slow gradually. Yesterday’s meeting echoed the ideas that recent indicators point to a modest increase in spending and that inflation has eased, precisely what the first innings of a recession would predict. As markets shortsightedly adopt the soft landing narrative, the Fed’s lack of pushback against easier financial conditions added fuel to the fire. Given this, it is doubtful that markets will stop rallying unless one of two cases occurs: First if data comes in hot, it potentially frightens the market into thinking the Fed will turn back hawkish and raise rates more than the recently observed 25bps hike. The second scenario is the other extreme. Should data start coming in highly recessionary with lower inflation and weak growth, this will eliminate all believers in the soft landing narrative, thus halting the rally. However, at present, it looks like the market rally of 2023 could continue until either of these scenarios happen. An important thing to note is that whenever inflation has exceeded 5% in the past, it has never come back down without the Federal Funds Rate exceeding the CPI. Considering the Federal Funds Rate is currently at 4.65% and CPI inflation at 6.5%, more rate hikes are on the horizon unless data comes in highly recessionary. CPI data on the 14th will provide significant insight into whether or not the Fed will follow the likes of the European Central Bank & Bank of England and go with a 50bps hike rather than a 25bps hike.

Another important thing to note is that Apple, Amazon, and Alphabet (the parent company of Google) all missed earnings last night. If three of the world's largest companies missed earnings, it does not breed confidence in the hopes of avoiding a recession. One thing is for sure, the S&P500 will take a hit when the NYSE opens later today.
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