Fed steps up hawkish talk; Tech sells, dip buyers return
The technology didn’t actually drive the sale. Homebuilding was the worst performing US sector last week, down 7.8%. Technology fell 3.8% and real estate 3.3% over the week.
Dip buyers return on Monday
On Monday, January 10, a substantial gap closed across all major US markets at the open. Dip buyers returned in droves to prevent the Nasdaq 100 from suffering a fifth straight session of losses. The rally was bigger than any such rebound from the depths of the coronavirus crash in March 2020. The move would see the Nasdaq 100 alone trading incrementally higher at Monday’s close than it did. Friday.
What the Minutes Say and Why It’s a Big Deal
The offensive comments in these Fed minutes are as follows:
“…it may become warranted to raise the federal funds rate sooner or at a faster pace than participants had previously anticipated. Some participants also noted that it might be appropriate to start reducing the size of the Federal Reserve’s balance sheet relatively soon after it begins to raise the federal funds rate.
Why was it so important? Because so far all the talk has been about curtailing purchases of existing assets and where the Federal Reserve can start raising interest rates. These minutes go further than the tapering currently underway, or raising rates at a faster pace (which the Fed has previously signaled).
The December minutes suggest that the Federal Reserve is considering ending Quantitative Easing and replacing it with Quantitative Tightening. When QE (which is by definition accommodative) goes away, financial conditions necessarily tighten and it is to the prospect of this tightening that the financial markets react.
But it’s more than that. The infamous taper tantrum of 2018 took place as the Federal Reserve was shrinking the balance sheet (quantitative tightening) the same time than rising interest rates. At the time, Powell managed to push the federal funds rate to 2.5% before a 20% drop in U.S. stock markets sent it swinging. It is to this combination of shrinking the balance sheet and rising interest rates that the markets are reacting.
Data to watch this week
Wednesday’s upcoming CPI reading should hopefully provide more clarity when it comes to inflation. Also, be sure to keep an eye out for the EIA’s Crude Oil Inventories report on the same day and the first US jobless claims on Thursday.
The question is how much tighter stock markets can tolerate and where inflation will be once that level is reached. Remember that stocks can rise with Fed tightening as long as growth levels are maintained. Corporate earnings will be a key factor to watch this week, as any sharp revision in growth expectations will attract investors’ attention and could lead to further declines in stocks.
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by Giles Coghlan, Chief Currency Analyst, HYCM
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