The perpetually key question in markets is, “what’s been priced in?” In other words, what new information could be surprising to investors? Usually, the answer is nothing. Some say the answer is always and invariably, nothing. But these people aren’t very fun, and certainly are not traders.
This question today is: have investors fully anticipated the Federal Reserve’s plan for 2022?
The S&P 500 and Nasdaq are near highs but the number of companies making new records is near the lowest since the Covid crash. Small-cap stocks are in a correction, and last year’s momentum trades are reversing. Crypto is in a bear market. The yield curve’s a pancake. There’s a strong case to be made that whatever disruption may come from Jay Powell’s hawkish pivot is already being worked through markets, and that hearing the Fed chair confirm such expectations should not add anything new to the equation.
Bloomberg economists expect the FOMC to double its pace of tapering and forecast three rate hikes for next year. Oftentimes with high-profile events like this, if the reality confirms the prediction, there’s some form of reversal of market moves that preceded the event: i.e., a “sell the news” reaction. (In this case, that would mean a bounce in stocks, particularly growth companies, a decline in the dollar, and a widening yield curve). That’s the most likely outcome if there’s no hawkish surprise.
But there is one compelling reason to think that despite all this, risk assets remain underprepared for monetary regime shift. Go to the bond market to see why. As I identified in this newsletter as early as July, the compression of the yield curve and the rising dollar were the key tells that the Fed would have to abandon its Average Inflation Targeting framework. Yet most analysts spent the summer and fall obsessing over used-car prices and lumber quirks to propagate the Fed’s “transitory” message that it’s since abandoned. The message went like this: inflation is transitory, Powell will hold dovish, and long-term yields reflect rock-bottom interest rates into the future.
Today’s FOMC likely nails the coffin in that theory. Problem is, a lot of people believed it, and used the explanation to justify buying stocks, for about six months. The yield curve peaked out and the dollar bottomed back in the late spring — about 20% ago in the Nasdaq 100
If Powell and Co confirm existing expectations but stocks still drop, the curve flattens and the dollar ramps, it’s a sign investors have not yet come to terms with how big a change this is from the Fed. That\’s a bad sign for bulls because and suggests volatility will continue. If, on the other hand, Powell confirms his about-face and risk assets rally anyway — in the face of a tighter policy regime — that would be quite a revelation for the bulls.