From Dovish Hike To Hawkish Pause

Powell Pauses, But More Hikes Likely In Store 

As the Federal Reserve approached its latest decision, there was speculation about whether it would result in a pause, a skip, or a hold on rates. Although the announcement seemed like a skip, Fed Chair Powell advised against categorizing it in such a way. It is important to recognize that despite being labeled as a skip, the Fed maintains its flexibility. Chair Powell emphasized that the Fed's projections are not fixed, and decisions will be made on a meeting-by-meeting basis. The central bank will now carefully monitor jobs and inflation data, and if there is a downward trend, it could provide an opportunity for the Fed to transition from a skip to a pause.

The uncertain lags with which monetary policy affects the economy, as well as potential headwinds from an on-going tightening in credit conditions were provided as the main reasons for maintaining the target range of the fed funds rate at 5-5.25%, the aim being to observe the effects of the tightening actions to date on the broader economy before committing to further hikes. 

In the previous March and May meetings, Jerome Powell delivered rate increases as largely expected by the market but wasn’t regarded as having been hawkish enough in his press conference remarks. In the recent June meeting, the FOMC opted to pause, maintaining the Fed Funds target rate at 5.00%-5.25%.

FOMC members raised their median dot plot expectations to a 5.6% Fed Funds rate by the end of the year, versus the 5.1% median projection that was provided in the dot plot from back in March. The expectation is now for two more hikes by the end of the year. All but two members of the committee expect the Fed to raise rates at least one more time, with two members expecting rates to remain where they are, and one member expecting four more rate hikes.  However, this move can be regarded as keeping the Fed’s options open and whether rate hikes will come for July will ultimately depend on the labour and core PCE data between now and then. 

No Cuts In 2023? 

With only four meetings left this year, even the most dovish of FOMC member predictions still points to the possibility of rate cuts being firmly off the table barring some unforeseen market event. Many will recall that back in January, the consensus was that the effects of tightening would probably weaken the US economy sufficiently by the middle of 2023, and that latter half of the year would probably see the Federal Reserve being forced to cut rates.  

This view was given further weight during the US regional bank turmoil that emerged in April. At that time, a total of 0.75% in rate cuts were being priced in. A surprisingly resilient US labor market and inflation readings still well above the Fed’s 2% target have pushed the likelihood of rate cuts further back.  

June’s Non-Farm Payroll report represented the fourteenth consecutive payroll beat, coming in at 339,000 to the market’s expectation of 193,000. The CPI data for May also suggests much stickier inflation than expected, with Core CPI unchanged, and both the broader monthly and yearly readings coming in only marginally lower than the market’s expectations.  

So, bear in mind that if there are no signs of a meaningful slowdown by the end of the summer, we could be entering Q4 with even higher rate expectations than at present.  

Gold Sells Off 

Gold has been one of the notable casualties of the Fed’s renewed hawkish position, dropping during the press conference to set new four-hour lower-lows. June’s FOMC decision represents the realisation of one of the main fears plaguing gold investors this year. Namely, that if the Fed manages to maintain its higher-for-longer stance, a higher rate environment would be a headwind to gold’s continued performance. However, the Fed has just affirmed its ability to be flexible. If inflation falls and it looks like the Fed could be justified in allowing the ‘skip’ in rates to become a ‘pause’, then gold could find eager buyers once again. In fact, gold has been one of the most popular assets among HYCM’s clients so far in 2023.

Gold is currently trading at around $1,944 per ounce, below the precious metal’s 100-day moving average. By comparison, the 100-day MA wasn’t even tested during the double-bottoms we saw in February and March. Gold’s retreat to this level and current failure to hold it as support is concerning, particularly since the next important line of support is to be found at the 200-day moving average, which is currently all the way down around $1850.  

Stocks Remain Elevated 

During the press conference, stocks dropped despite the pause in hikes, investors appearing to come to terms with the reduced likelihood of rate cuts for the remainder of 2023, at least if the dot plot is to be believed. During the heightened volatility surrounding the meeting both the S&P 500 and the Nasdaq 100 retreated to their respective 20-period moving averages on the 4-hour timeframe, only to find buyers at these levels. Both benchmarks closed up on the day but have since started to return some of those gains as participants digest the event and begin to look forward to the July meeting. 

Even as markets appear to be gradually coming round to what Jerome Powell has been flagging for some time now, we still see the S&P 500 closer to 4400 than to 4000, and the Nasdaq on the verge of 15,000. Both indices have set impressive new weekly higher-highs, with the Nasdaq currently attempting to break its March/April 2022 highs.

Final Thoughts 

The AI rally is perhaps what’s most concerning about the above picture in US equities. This is because the hype surrounding Artificial Intelligence is mostly what’s supporting US stocks at the moment. There’s nothing to suggest that AI as a narrative, and the stocks most likely to benefit from it, can’t keep supporting US equities for some time to come. 

However, the heights at which these names have reached raises some concerns because they have much further to fall. Nvidia is currently setting the highest overbought RSI level on the weekly time frame since 2016. The worry is that should some of these names start to return some of 2023’s gains, it could lead to them taking so much else down with them.  

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