Wednesday, Dec. 15, saw the conclusion of the most highly anticipated Fed meeting of the year as investors try to get a feel for the type of economic climate they'll be trading in the New Year.
Federal Reserve chairman Jerome Powell stepped up the hawkish sentiment in an attempt to let the broader market know that the easy money policy it has been engaged in since the pandemic is drawing to a close. Inflation is now in the spotlight in a big way, with a great deal of pressure coming down from Washington to address multi-decade highs in consumer prices.
Part of this new hawkish turn from the Fed will see it accelerating the $15 billion taper of asset purchases it started in November. December will see it doubling this total to $30 billion, to increase it further from January onwards.
This should put the Fed in a position to start hiking rates in the first half of 2022 as it cannot feasibly do so while still providing market support through its asset purchases. Interest rate projections courtesy of the Fed's "dot plot" reveal that Fed policymakers expect a total of three interest rate hikes in 2022, with a further two in 2023 and two more in 2024.
This was undoubtedly the bigger of the two policy adjustments. The market had been primed for an acceleration of the taper; however, the content of the dot plot was more hawkish than expected.
Powell Pivots
This represents a substantial pivot in the policy. The Federal Reserve has been attempting to prepare markets since it retired its transitory language surrounding the inflation question and started communicating the need to raise rates.
Interestingly, Wednesday's meeting is where we gained insight into hawkish FOMC members' thoughts. Only six of eighteen members currently expect fewer than three rate hikes in 2022, and no members currently expect to continue the current lower-for-longer policy.
This latest pivot (you'll recall Powell's original pivot went from hawkish to dovish in 2019) sees the Fed turning its focus away from one of the items of its dual mandate, full employment, to what the Fed believes is currently the more pressing of the two concerns, price stability.
Powell said,
“It feels likely now that the return to higher [labor force] participation is going to take longer. At the same time, we have to make policy now and inflation is well above target.”
This is despite already having stated that the Fed would not raise rates until it's full employment criteria are satisfied.
Market Reaction
All major US indices rallied on the news. The S&P 500 was up more than 1.5%, the Dow Jones Industrial Average rallied by a modest 1%, the Russell 2000 by around 1.6%. Still, the tech-heavy NASDAQ was the day's true winner, up around 2.4% on the day.
US markets pared these gains during the following session; the Russell 2000 was down by 1.9% on Thursday. The Dow was also down by 1.1%, the S&P 500 by 1.4%, and the NASDAQ led the rout, down over 2.8%.
The recent risk-off sentiment has hurt tech. As you can see above, while the S&P 500 and Dow Jones Industrial Average have recovered to their 20-day moving averages, the NASDAQ is currently testing the 50-day.
However, the big losers remain the small-cap companies of the Russell 2000, which are far more sensitive to inflationary pressures and supply chain disruptions. The Russell is currently trading below all its major moving averages and appears to be testing a double-bottom formation daily.
Different Interpretations
On the surface, the sentiment surrounding this most recent Fed meeting has been extremely hawkish. However, Powell left ample room for understanding in the Q and A that the Fed is not blindly moving towards its targets regardless of broader financial conditions (as suggested by its policy choices before the pivot in 2019).
When asked about the potential risks to financial stability an accelerated taper and rate hike would pose, Powell let it be known that the Fed would monitor financial conditions and respond appropriately to a scenario of slowing growth. This is what financial markets want to hear, and it offers a different explanation for Wednesday's decision than markets being comfortable with three rate hikes in 2022.
Markets know the Fed is keen to avoid a tantrum like 2018's, 2018's they've told in so many words that the Fed isn't on a set course. The question on the table now is what it will take to cause Powell to pivot again?
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