FOMC: How Hawkish?

Yesterday’s US producer price index came as a slap in the market’s face, as the latest data showed that goods costed close to 10% more at the factory gate in November, a terribly high number for the US that the Federal Reserve (Fed) must deal with ASAP.

Investors’ eyes popped out of their heads when they saw the 9.6% PPI figure, and the hawkish expectations topped sending Nasdaq more than 2% lower during the session. The technology-heavy index still recovered to the close, but ended the session more than 1% lower. The S&P500 slid 0.75% and the Dow dropped some 0.30%.

The kneejerk reaction to the US PPI data is reasonable, but it may be more fear than harm when it comes to how strong the Fed will react to it. Walking in today’s decision, we already know that the most important take of this year’s last FOMC meeting is inflation being no more ‘transitory’. We already know that the Fed is preparing to announce a faster QE taper, and to hint at perhaps sooner and faster rate hikes to cool down the inflationary pressures. And that’s already mostly priced in. The US 2-year yield is up from 0.10% to 0.70% since May.

At this point, no one at the FOMC board is willing to destroy the stability that has been achieved in the stock markets during what was supposed to be tough pandemic times. No one at the Fed wants to trigger a market rout, a financial crisis nor panic across the market to rush to tame inflation. On the contrary, the Fed will need to have a subtle strategy in place when it pulls the rug from under the market’s feet, without wreaking havoc in asset prices, because asset prices do matter for the Fed and the Fed will be in a better position to fight inflation with the support of healthy financial markets, or at least without the urge to deal with a renewed financial calamity.

Therefore, no matter how late the Fed realizes that inflation’s gone ahead of itself, and no matter how loud the economy is calling for help, the Fed can move only so fast.

Also, we know by fact that, as much as the Fed likes doing dovish surprises, which please investors, they hate the hawkish surprises which would destabilize the financial place. Because a hawkish surprise, and a market selloff would only delay the Fed action and get things worse even in terms of inflation. And this is exactly why we have forward guidance. And the forward guidance for this week’s meeting is faster QE and a possible revision of the timing of the first rate hike. And that hawkish shift is already priced in. Therefore, it would be surprising to see a significantly more hawkish FOMC announcement. Hence, there is hope for a relief rally in risk assets following today’s FOMC decision. All three major indices have come close to their 50-dma levels, which could be an interesting dip buying opportunity for investors if the mood after the FOMC improves. If the fear of missing out a further rally, so the so-called FOMO remains tight, there is no reason we won’t see new records even with Fed pulling away support faster.

Plus, there is one development that could help the Fed maintain hope that inflation may come close to a peak: the stagnant oil prices. The barrel of US crude remains under pressure near the $70 level, as the International Energy Agency now says that the oil market has returned to a supply surplus and faces a bigger overhang in 2022 with the new travel restrictions thanks to an endless pandemic and higher supply with the release of strategic oil reserves from the US and other countries, and higher OPEC output. For now, the ‘risk’ of seeing the Iranian oil hit the market has reduced however, as the talks on the nuclear front don’t progress much.

But it looks like, even if the impact of omicron is seen limited thanks to vaccination, it makes it harder to get the oil rally going above the $70 mark. As a result, there is a stronger case for a further pullback in oil prices toward the $60 mark, rather than a further rally toward the $80 level.

Swissquote Bank SA
Swissquote Bank SA
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