Fed To Surprise!

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KR opinion

As we commenced this week, market volatility significantly diminished. Monday's narrow trading range set a subdued tone, with expectations that this calm would extend into Wednesday's Federal Open Market Committee (FOMC) meeting.

Originally, the Employment Cost Index (ECI) was expected to be not particularly impactful, at a 1% increase. However, the rise to 1.2% catalyzed a notable shift in market dynamics, leading to substantial selling and reinforcing concerns about persistent inflation.

This shift in sentiment painted a gloomy picture as we approached the Federal Reserve meeting. Market participants seemed resigned to expect continuity in policy with no significant actions from the Fed.

However, I have consistently suggested that this meeting could be pivotal. If the Fed were to make a statement, it might scale back on quantitative tightening (QT), a move that could alter market expectations. Although I have no concrete predictions about the Fed’s decisions,

I believe any announcement on reducing QT could be more influential than changes to the Federal Funds Rate, which might affect market sentiment initially but would likely have a minimal impact on the overall banking system.

Apart from the Employment Cost Index ECI, other economic indicators released included a 1.2% increase in the Federal Housing Finance Agency (FHFA) house prices and a 7.3% rise in the Case-Shiller home price index, significantly above the expected 6.7%.

However, the Chicago Purchasing Managers' Index (PMI) aligned with forecasts, and the Consumer Confidence Index fell to 97, below the anticipated 104, casting a slight pall over economic optimism.

With the first month of Q2 closing, we observed a challenging start, with the S&P 500 and NASDAQ declining by 4.2% and 4.4%, respectively. This sets a backdrop of heightened volatility as we move deeper into the quarter. Moreover, a significant yet unconfirmed reversal in the S&P index occurred, which will require close monitoring.

Monitoring these developments, particularly any discourse surrounding QT adjustments is crucial as we continue.

The nuances of these economic indicators and Federal Reserve decisions will undoubtedly play a critical role in shaping market expectations and strategies moving forward.

Looking Back on Yesterday’s Action

Stocks declined today, with the Nasdaq Composite dropping 2.0%, more than the S&P 500’s 1.6% decrease and the Dow Jones Industrial Average’s 1.5% fall. Initially, the major indices performed relatively well until several large-cap stocks reversed their earlier gains.

Notably, NVIDIA, which had increased by 1.2% at its peak, closed down 1.5% at $864.02, and Meta Platforms, which had risen 1.6%, ended the day down 0.6% at $430.17.

The sharp downturn just before the close was attributed to last-minute selling as traders de-risked their positions at the end of the month. For April, the S&P 500 fell by 4.2%, the Nasdaq Composite by 4.4%, and the Dow Jones by 5.0%.

Increased market rates fueled the downward trend in today’s market following this morning's release of the Employment Cost Index for the first quarter, which showed a 1.2% rise in compensation costs against a forecasted 1.0% increase. This data added to concerns about persistent inflation and the Federal Reserve potentially delaying rate cuts.

Yields on Treasury notes also rose, with the 2-year note yield increasing by eight basis points to 5.05% and the 10-year note yield rising seven basis points to 4.69%.

Almost all stocks were affected by this broad market pullback. The equal-weighted S&P 500 dropped by 1.5%, and all 11 sectors closed in the red. However, some exceptions, like Eli Lilly, Corning, and 3M, saw gains following positive earnings results.

Investors are now looking forward to tomorrow's Federal Open Market Committee (FOMC) policy announcement and Federal Reserve Chair Jerome Powell's press conference, keen to assess any changes in the Fed's stance in light of recent inflation data.

·S&P 500:+5.6% YTD

·Nasdaq Composite: +4.3% YTD

· S&P Midcap 400: +2.9% YTD

·Dow Jones Industrial Average: +0.3% YTD

·Russell 2000: -2.6% YTD

Reviewing Tuesday’s  economic data:

- The Q1 Employment Cost Index was reported at 1.2%, higher than the anticipated 1.0% and up from the previous 0.9%. The key takeaway is that compensation costs have accelerated from the previous quarter, raising concerns that general price inflation may remain above the Federal Reserve's 2% target for an extended period.

The February FHFA Housing Price Index increased by 1.2%, reversing the previous decline of 0.1%.

- The February S&P Case-Shiller Home Price Index rose 7.3%, exceeding the forecasted 6.7% and up from the prior 6.6%.

- The April Chicago PMI registered at 37.9, significantly below the expected 44.5 and the previous 41.4.

- The April Consumer Confidence index stood at 97.0, falling short of the forecasted 104.0 and down from the revised figure of 103.1. The report highlights a disparity between consumers’ current optimism about economic conditions and their concerns about future business conditions, job availability, and income—a sentiment that could lead to a slowdown in discretionary spending if worries about income security intensify.

Looking ahead to Wednesday’s economic data releases:

- At 7:00 ET, the Weekly MBA Mortgage Index will be updated, following a previous decrease of 2.7%.

- At 8:15 ET, the April ADP Employment Change is anticipated to be 175,000, compared to the prior 184,000.

At 10:00 ET, March Construction Spending is expected to show a 0.4% increase after a previous decline of 0.3%. The April ISM Manufacturing Index is projected to remain steady at 50.0% compared to the prior 50.3%.

- At 10:30 ET, the update on Weekly crude oil inventories will be released, following a prior decrease of 6.37 million barrels.

Finally, the May FOMC Decision is expected at 14:00 ET, with rates forecasted to remain unchanged at 5.25-5.50%.

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