What To Watch When FOMC Minutes Drop: Pain For Stocks, Bonds Looms If Market Expectations Diverge With Fed Reality

The Federal Reserve will release the minutes Wednesday of the May FOMC meeting, at which policymakers hiked the policy rate by 25 basis points to 5-5.25% and signaled they were shifting to a data-dependent approach.

A sizable majority of Wall Street analysts are of the opinion the rate hike in May was the last of this cycle, a sentiment also echoed by market participants, who have further increased bets on several interest rate cuts starting from the third quarter of the year. 

The Fed minutes are anticipated to provide an important reality check for market interest rate expectations, since they differ substantially from what Fed officials might have in mind, or at least have recently expressed. 

May FOMC Minutes: What To Watch

• In May, the Fed raised interest rates to 5-5.25%, matching the median dot plot in March economic forecasts.
• Investors will scrutinize the FOMC minutes to see if participants are satisfied with the present level of interest rates and whether circumstances warrant further tightening.
• The minutes might give further information on the danger posed by regional banks, credit tightening, policymakers' perspectives on the debt limit crisis and the economic outlook.
• The markets now assign a 75% probability of the Fed keeping rates unchanged in June and factor in about 160 basis points of interest rate cuts until November 2024, according to the CME Group FedWatch tool.
• Some Fed speakers have lately sounded slightly more hawkish than anticipated, while Fed Chair Jerome Powell has signaled that tighter banking credit may limit the need to increase rates further. As a result, it will be critical to watch for signs of divergence among FOMC members about the future path of interest rates.
• St. Louis Fed President James Bullard recently backed two more hikes in 2023. The New York Fed's John Williams said the natural level of interest rates could be higher than before the pandemic.
• San Francisco Fed President Mary Daly vowed to keep options open in June. Minneapolis Fed President Neel Kashkari sounded more dovish than his colleagues, indicating he's open to a rate pause in June.

The Most Sensitive Assets When FOMC Minutes Drop

Some of the most exposed assets to rate expectations and growth outlook are likely to experience volatility as a result of the FOMC minutes. 

The Ishares 1-3 Year Treasury Bond ETF SHY is especially sensitive to forthcoming Fed interest rate decisions, whilst the iShares 20+ Year Treasury Bond ETF TLT is more likely to react to remarks over inflation and growth. 

The stock market will be especially cautious about the FOMC minutes, considering the recent rally was also in part fueled by growing investors' expectations over Fed rate cuts. As a result, a realignment of those expectations might be problematic for the SPDR S&P 500 ETF Trust SPY and the QQQ Invesco Trust QQQ.

Read next: Preparing For A Potential S&P 500 Index Swoon

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