Monday, February 6, 2023
Homemarket insiderThe Fed will continue to dominate the market in the week ahead...

The Fed will continue to dominate the market in the week ahead after sell-off

  • The Fed set off turbulence in stocks, bonds and currency markets this past week when it signaled it was discussing moving toward tapering its bond-buying program.
  • That turbulence has heightened the focus on the Fed and inflation, so comments from Fed Chairman Jerome Powell, before Congress on Tuesday will be important in the week ahead.
  • There is also key inflation data late in the week, when the Fed's preferred inflation measure, the personal consumption expenditures inflation index, is released.

Traders on the floor of the New York Stock Exchange.Source: NYSE

The Federal Reserve's signal that it is looking to step away from some of its easy policy is expected to be a dominant trading theme in the week ahead and likely for the rest of the summer.

In the past week, investors repositioned across the financial markets after Fed Chairman Jerome Powell said Wednesday that the central bank was considering tapering its purchases of Treasurys and mortgage securities. That is important since when the Fed eventually acts, it would be the first serious reversal of the easy policies it put in place to add liquidity to markets when the economy shut down last year because of the Covid crisis.

The purchases, which amount to $120 billion a month, would be gradually whittled away once the Fed decides to slow down and end the bond buying, or quantitative easing. That could then open the door to interest rate hikes, which the Fed now projects would come in 2023.

The Federal Reserve sent ripples across financial markets after its meeting Wednesday. The dollar jumped, stocks fell and bond yields moved to imply higher short-term interest rates in the future. The Dow fell 3.5%, its worst week since October. The S&P 500 was down 1.9% for the week, its worst weekly loss since February, and the Nasdaq lost just 0.3%, helped by a small weekly gain in tech.

"I think the market is still digesting the Fed meeting," said Ed Keon, chief investment strategist at QMA. Stocks were trading sharply lower Friday, after weakness Wednesday and Thursday. Yields fell on longer duration bonds, like the benchmark 10-year, but rose on the shorter duration 2- and 5-year notes.

The spreads between those shorter-duration notes and the 10- and 30-year bond yields narrowed dramatically in a so-called flattening trade. That's common when interest rates are rising. The higher short rates reflect the expected increases in the fed funds rate, while the longer duration yields fall, because the thinking historically has been that a tightening Fed slows the economy.

The Fed also provided new economic forecasts, including a chart on interest rates that shows it expects to hike its fed funds rate twice in 2023, after its prior forecast included no increases.

Fed speakers will get a lot of attention in the week ahead. Powell speaks Tuesday before the House Select Subcommittee on the Coronavirus Crisis on the Fed's policy response and the economy. His remarks could be a highlight of what looks to be a slow, but volatile first week of summer for markets.


Most Popular