The new Fed policy is not bullish for equity markets. There. I said it. While many have been parsing the Fed’s statement and Chair Jerome Powell’s post-meeting press conference, I could see the writing on the wall.
And it’s not like we were surprised. Fed governors have been hinting at what’s to come in speeches and testimony over the past few months. So what roiled the markets?
The markets weren’t on great footing to begin with
Price action was abysmal leading up to the Federal Open Market Committee meeting last week. On the day of the meeting, the Nasdaq fell below the 50 ma for the second day in a row – ouch. Once the Fed announced their new policy, the bulls snapped off a sharp two-hour rally, and markets closed near the highs of the session.
The Nasdaq performed well enough, before it lost those gains – and then some. After rising 2%, the QQQ (Nasdaq 100) fell more than 2.5%. Volatility is here to stay!
New Fed policy has traders nervous
So back to our original question – what roiled the markets? First, the Fed announced they would accelerate the taper of bond purchases and hope to wrap everything up by March.
Next, they signaled a distaste for the latest inflation readings. That was a given after the CPI posted its highest reading in more than 40 years and the PPI posted its highest gain ever (9.6%).
All of us consumers have been feeling the squeeze of higher prices caused by many issues, starting with the supply chain. Those issues will eventually be addressed, but at what cost? Recently Chair Powell stated that our current levels of inflation are no longer transitory. I interpreted that to mean inflation will be more permanent, which is nothing to be happy about.
In addition to the taper, the committee will hike interest rates sooner and more frequently than expected. That will eventually put pressure on bonds, but for now the equity markets are going to be re-priced. What does that mean exactly? The earnings yield, which has been high under the zero interest rate policy, will eventually be adjusted lower. The market multiple will be adjusted lower as well. That’s what has traders nervous.
These changes do not reflect the strength or health of the economy, which seems fine. But, higher interest rates – even starting from a lower base – are going to cause headwinds for equity markets as liquidity dries up.
The Fed has changed the game. As traders, we need to adjust.