Sat, May 08, 2021 @ 22:26 GMT
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The Calm Before The Fed Storm?

Investors are looking forward to the outcome of the FOMC meeting later on Today. Ahead of this, sentiment towards risk remains overall positive thanks the recently passed $1.9 trillion US fiscal stimulus and hopes that the economic recovery will accelerate in the coming months as lockdowns are slowly lifted. Indeed, investors chose to ignore the 3% month-over-month drop in February retail sales and the 2.2% m/m fall in industrial production on Tuesday as they continue to look ahead to the future. The major US stock indices hit new record highs and the Nasdaq also climbed higher, making back a good chunk of its recent losses, before easig off their highs to close mixed. Index futures were flat Wednesday morning.

Will the Fed spoil the part for the equity market bulls?

The FOMC will provide us with fresh economic and interest-rate projections on Wednesday. It is reasonable to assume that the Fed will not want to scare the markets by being too hawkish, but the devil will be in the detail or details of those economic and interest rate projections. Policymakers are aware that the market-based gauges of inflation have been rising amid bets on faster economic recovery and rising oil prices. The markets are pressuring the Fed to react, in other words. So, at the very least, expect to see some subtle changes in the dot plots. At the previous update, the Fed was projecting no rate hikes until 2024. But that seems very unlikely given the huge fiscal support from governments of the major economies, not least the US. The Fed can’t allow inflation to run too hot for too long.

If the Fed projects that interest rates will rise a lot sooner, then this may spook investors and cause the dollar to rally. Insofar as the equity markets are concerned, well the potential downside could be limited for value stocks in response to a hawkish dot plot. The Fed will probably use the excuse of unemployment being too high to keep current policies intact for a while yet to let the economy heat up further. This should keep value stocks in demand but could hurt growth and tech names.

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