What a difference a day makes
24 little hours
Brought the sun and the flowers
Where there used to be rain
- Dinah Washington, jazz singer
What a difference a day makes from an equity rally to an equity sell-off after the Fed raised rates 50 bps. Yesterday, immediate reaction from the FOMC announcement was indifference as though the 50 bps rise was baked into market prices. the We have commented that the rally started after Fed Chairman Powell stated that a 75 bp rise was not under consideration. The tail event of a Fed rate shock was taken off the table for the near-term and markets viewed this as good news. The short-term probabilities for the size of the next rate hike changed massively.
Today was a different story as the combination of a 50 bps rate hike, the growing belief that the Fed is behind the curve, the relentless rise in inflation, and the overhang of stagflation all weighed on investors who sold risk assets and fixed income alike. Bonds were not a safe asset albeit did not decline as much as stocks.
Markets are fragile and the story for repricing is still strong. One the discount rates for cash flows are going higher even if only through 50 bps hikes. Investors are less optimistic of a soft-landing story. The Fed has little creditability as a forecaster. However, our view of what is most important is the behind the curve story of the Fed. Not considering large hikes and following what seems like a slow QT roll-off program suggests that the Fed is still not serious about curtailing inflation relative to ensuring aggregate demand. Unfortunately, an inflation-shocked economy may slow - the stagflation story seems to be the dominant thinking of investors.
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