The FOMC yesterday raised rates another quarter point to their highest in 22 years, with a further hike still on the table. With the move already fully priced in, market impact has been minimal and equities are on the up, while the buy-side appears unflustered. But this time round, it’s retail driving the volume…
The Federal Open Market Committee (FOMC) on Wednesday 26 July took the decision to raise its funds rates another 25 bps to a range of 5.25-5.50%, bringing the benchmark rate to its highest in well over two decades. But with the move widely expected across the market, and already priced in by most players, the impact has so far been minimal.
No alarms…
“Ahead of the FOMC meeting, markets remain[ed] relatively calm,” confirmed Jeffrey O’Connor, head of market structure, Americas, at Liquidnet, who cited the mood as one of “quiet confidence”.
“The hike was all priced in by the market,” agreed Stephane Marie Francoise, multi-assets trader at Unigestion, speaking to BEST EXECUTION.
Despite the measured approach, there is still everything to play for. Policymakers at the last meeting in June certainly indicated that two further rate rises could be on the cards this year, but the language has undergone a subtle change since then, with Federal Reserve chairman Jerome Powell yesterday taking a coyly cautious stance.
“I would say it’s certainly possible that we will raise funds again at the September meeting if the data warranted,” he commented. “And I would also say it’s possible that we would choose to hold steady.”
Although economy still has “a long way to go” to meet the Fed’s 2% inflation target, Powell stressed that the decision would be made by “careful assessments… meeting by meeting”.
“The speech from the Fed was a little more doveish than expected and this could help the market to perform a little bit more in the short-term,” predicted Marie-Francoise.
The Dow Jones hit a 13-day rally yesterday, its best performance since 1987. It gained 0.23% on news of the rate rise and is up 4.10% over the past month and 7.16% year-to-date. The S&P remained unmoved, shifting down a fraction (0.016%) on Wednesday but gaining 2.61% over the month and 18.94% over the year, while the tech-heavy Nasdaq (which implemented a special rebalance to accommodate the AI boom on Monday) slid a nominal 0.12% following the news but is up 4.22% over the month and a notable 36% for the year so far.
…and no surprises?
With equities on the up and optimism pervading across the street, the markets (on the equity side, at least) look to be settling in for a more stable summer.
The outlook remains optimistic despite the Fed’s continued hawkish stance, supported by positive indicators including promising earnings figures and economic reports that increasingly signal a soft landing. Much of this, however, is being driven by retail participation, rather than the traditional institutional money manager.
“With US equities outperforming, that draws higher retail participation, and total market volumes sourced here are at the highest end of the range,” said O’Connor. “And the almost guaranteed business of momentum funds grabbing onto the move to push to fresh highs. So while the confidence is there, it is more so coming from these sources. It is worth noting that this retail bullishness (from a number of measures) is reaching to extreme highs, which historically has been a contrarian indication.”
On the other hand, institutional behaviour is looking rather less predictable, with the buy-side continuing to hang back.
“As the summer season takes hold and we wait on swathes of earnings and economic data, we’re continuing to see divergence in institutional trading behaviour,” noted O’Connor. “Quant funds’ participation remains high and continues to propel markets. However, while traditional buy-side firms’ activity has picked up in recent weeks, it remains muted despite more favourable trading conditions.
Dollars and cents
Some of this could be down to caution over future rate moves, but many are waiting to see what the latest economic data shows before making a move – with earnings a key indicator that will drive activity.
“Earnings can go a long way in helping to settle the bulls vs bears tug of war,” said O’Connor. “The path of least resistance has been higher, riding the themes of disinflation traction, soft landing scenario, and peaking Fed. At this point, the bears will say that valuations are stretched.”
According to John Butters, senior earnings analyst at FactSet, total earnings for the S&P 500 as of 21 July (accounting for 18% of companies) were down –9% for Q2, despite 75% of firms reporting a positive earnings per share (EPS) surprise. “If -9.0% is the actual decline for the quarter, it will mark the largest earnings decline reported by the index since Q2 2020 (-31.6%). It will also mark the third straight quarter in which the index has reported a decrease in earnings,” noted Butters.
But there is hope on the horizon. Around 40% of S&P companies are reporting their results this week, and based on index performance (as above) the figures are not yet down enough to dent the rally – particularly from the perspective of consumer resilience.
2 + 2 = 5?
“With the FOMC out of the way, and a couple of important inflationary readings, earnings will go a long way taking us to the Jackson Hole Economic Symposium at the end of August,” said O’Connor.
And the next couple of quarters could do even better.
“Looking ahead, analysts still expect earnings growth for the second half of 2023,” said Butters. “For Q3 2023 and Q4 2023, analysts are projecting earnings growth of 0.1% and 7.5%, respectively.”
For the buy-side the word on the street remains caution, but there appears little concern around future rate hikes – on either side of the pond, as the European Central Bank (ECB) is also set to make its latest decision today.
“Between September and November there is a 50% chance for a new increase, and this could be the last one,” predicted Marie-Francoise. “But it will depend on the coming reports for inflation and employment. Now it’s ECB day and that should be a non-event as well.”
©Markets Media Europe 2023
