Risk on or off
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Stocks Are at Risk Even if the FOMC Meeting Changes Nothing

By:Ilya Spivak

Stock markets may fall after the Fed policy announcement even if the priced-in rates outlook is little-changed

  • The Fed is widely expected to keep rates unchanged in September, eyeing cuts in 2024.
  • Narrowly tuned market pricing sets the stage for volatility as traders reposition.
  • Markets may default to a “risk-off” response even on status-quo Fed guidance.

The mystery seems all but gone from September’s Federal Reserve monetary policy decision. Nevertheless, it's likely that a potent market-moving outing looms ahead.

Officials are overwhelmingly expected to keep the target range for the benchmark Fed Funds unchanged at 5.25% to 5.50%. The priced-in probability of a 25-basis-point (bps) increase is a paltry 0.8%. The cumulative likelihood of such an increase before year-end peaks at 45% in December, before the focus quickly shifts to rate cuts in the second half of 2024.

The first 25 bps reduction is expected by July. Another one is fully priced in by November, with an 84% probability of a third by the end of 2024. That would put Fed Funds in a target band of 4.50% to 4.75% by the end of next year. That range lines up neatly with the Fed’s June forecast putting the median rate at 4.6% next year.

Fed faces tough balancing act as inflation bets rise, growth cools

The markets appear precisely tuned for a status-quo result, implying that any changes to the forecast have scope to push asset values around as traders reposition.

Investors’ priced-in inflation expectations have been creeping higher since the beginning of the month, inviting Chair Jerome Powell and his colleagues on the FOMC rate-setting committee to retort. Pushing the 2024 rate forecast to 4.8% or higher might follow. Revising expected inflation higher in tandem would cement the point.

Pulling in the opposite direction, Purchasing Managers Index (PMI) data suggests economic growth has cooled to near standstill. September’s update due this week is projected to put the composite PMI gauge at 50.4, a hair above August’s six-month low of 50.2 and worryingly close to the 50 boom-bust threshold separating expansion and contraction.

S&P Global U.S. PMI
Data source: Bloomberg

Stock markets at risk after FOMC announcement

The balance of risks for any adjustments seems adversely tilted for stocks as well as cyclically minded currencies and commodities like the Australian dollar and copper. Signaling a “higher for longer” rates path might spook investors worried about global recession. A dovish dispensation might be seen as endorsing those very fears.

Beyond economic projections, the statement accompanying the policy decision as well as the press conference with Powell following the announcement will give traders plenty of fodder to consider. That leaves ample room for speculation at a moment when the window for “risk-on” stability seems especially narrow.

Finally, even a perfectly executed balancing act may be met with a strong response. Markets are acutely aware that the Fed’s inflation fight threatens to kick out the last bit of support for global growth. China has struggled to reboot since emerging from COVID-19 lockdowns in December and the Eurozone may be in recession already.

If the U.S. central bank manages to keep speculation on its own actions relatively steady, their implications for the worldwide economy may still seem sobering. Without an obvious reprieve—an unlikely result, which could yet backfire if it appears too defensive (as noted above)—a “risk-off” result may be default.

Inflation Expectations vs. Fed Policy Outlook
Data source: Bloomberg

Ilya Spivak, tastylive head of global macro, has 15 years of experience in trading strategy, and he specializes in identifying thematic moves in currencies, commodities, interest rates and equities. He hosts Macro Money and co-hosts Overtime, Monday-Thursday. @Ilyaspivak

For live daily programming, market news and commentary, visit tastylive or the YouTube channels tastylive (for options traders), and tastyliveTrending for stocks, futures, forex & macro.

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