Powell Pulls Rug Out From Euphoric Fed Statement Reaction, Terminal Rate Spikes

US equity markets were weaker into the FOMC statement after ‘good’ news from ADP on the labor market. The FOMC statement was met with euphoria in stocks as traders saw hopes for a ‘pause’ but Powell pissed in that punchbowl during the presser with the following exchange:

“the labor market continues to be out of balance, with demand substantially exceeding the supply of available workers” reinforces the notion that the Fed is looking at both employment and inflation as giving it plenty of reasons to keep tightening.

Powell reiterated previous comments that “at some point” it will become “appropriate to slow the pace of increases.”

But most notably pointed out that there is “significant uncertainty” around that end-point.

“We have some ways to go,” adding that the ultimate level of the terminal rate may be higher than previously expected.

“The question of when to moderate the pace of increases is now much less important than the question of how high to raise rates and how long to keep monetary policy restrictive.”

And after the initial euphoric reactions, markets all reversed as Powell basically hinted that rates will stay ‘higher for longer’:

“…pausing is not something we’re thinking about…”

Simply out, as Bloomberg’s Ed Harrison concluded, “the downshift in the pace of policy tightening is now irrelevant.”

Terminal rate expectations ended the day at new cycle highs (above 5.10%) and rate-cut expectations shifted hawkishly…

Source: Bloomberg

Rate hike expectations for Dec and Feb initially dropped but that all reversed after Powell’s comments with Feb 50bps hike odds now higher on the day (at 60% by the close)…

Source: Bloomberg

The market just keeps repricing rate expectations ‘higher for longer’ against its will…

Source: Bloomberg

That dragged stocks back down. Nasdaq and Small Caps puked over 3% (from up over 1% right after the FOMC statement). The S&P was down over 2%…

We note that the S&P stalled at its 100DMA and then tumbled back below its 50DMA…

The Dow broke back below its 200DMA…

As Bloomberg’s Ye Xie noted, Powell has just flipped his argument of risk management.

Prior to the pandemic, the Fed’s story line has been that they’d rather let inflation run hot, than allowing inflation to stay too low for too long. It’s easier to deal with inflation than deflation, so goes the argument.

Today, Powell says it’s the other way around. It has tools to clean up over-tightening rather than to let inflation stray from the target for too long.

Times have changed.

Powell discussed his favorite yield curve indicator – The 3-month/18-month forward spread – noting that it is something The Fed monitors. It is on the verge of inversion (currently implying a 31% chance of a recession in the next 12 months)…

Source: Bloomberg

But, he reiterated that they clearly would prefer to over-tighten than under-tighten:

• *POWELL: IF WE OVERTIGHTEN, WE CAN SUPPORT ECONOMIC ACTIVITY

• *POWELL: IF WE UNDERTIGHTEN, RISK IS INFLATION ENTRENCHED

So the pain will continue until inflationary morale improves…

Treasury yields swung wildly on the day, diving dovishly on the statement then spiking hawkishly on Powell’s comments. The short-end underpeformed…

Source: Bloomberg

10Y Yields briefly dropped below 4.00% before ripping back higher but the 5Y yield saw the biggest swings of all maturities today…

Source: Bloomberg

The dollar puked lower on the FOMC statement but completely reversed that on the ‘higher for longer’ tone from Powell…

Source: Bloomberg

Bitcoin tumbled back from an initial kneejerk higher to test back down to $20,000…

Source: Bloomberg

Gold pumped (on the FOMC statement) and dumped (on Powell’s hawk-tardishness)…

Oil managed to hold on to gains (Saudi/Iran headlines) on the day despite weakening on Powell’s hawkish tone…

Finally, one has to believe The Fed knew they were laying a trap for the markets today – confirming dovish narrative from the blackout period with the statement then pulling the rug out during the presser with hawkish rhetoric.

Arguably, one might believe The Fed wanted to get financial conditions back under their control…

…and once again stomp on the over-enthusiastic hope of equity market dip-buyers…

And next week we have CPI and Midterms to look forward to!