Stock Rout Takes Breather on Fed Vow Big Hikes Won’t Be the Rule

(Bloomberg) -- When the S&P 500 Index loses a tenth of its value in five days, it doesn’t take much to get it to bounce.

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That’s the simplest interpretation of price action that followed the Federal Reserve’s biggest rate hike since 1994, expectations for which had sent the stock market reeling over the past week. Assurance by Chair Jerome Powell that similar medicine won’t be common in the future was enough to make Wednesday only the fourth winning day of the month for bulls.

Stock skeptics note that the same thing happened after the last Fed meeting on May 4, when Powell pooh-poohed the notion that 75-basis-point hikes would be needed to subdue red-hot inflation. The comment spurred a 3% rally that day. The S&P 500 is down every week but one since.

Since then, inflation has gotten worse. While Powell may have succeeded in halting one of the most volatile stretches for equities in a decade, his warnings that growth will slow and unemployment climb as a byproduct of the quest to tame inflation did little to convince anyone Wednesday’s risk-asset rally is sustainable.

“We need to stop confusing ‘dovish’ with what got priced because of leaks before the meeting,” Dennis DeBusschere, the founder of 22V Research. “A bounce because things got priced is not dovish, just oversold conditions adjusting.”

Regardless, traders took Powell at his word that three-quarter-point hikes won’t be “common.” Swaps showed that a full 75-basis-point move at July’s meeting was priced out in the aftermath, while Barclays Plc shifted its forecast for the central bank to return to a half-point increase next month.

While that left two-year Treasury yields lower by nearly 21 basis points on the day, the repricing since May’s meeting has been dramatic. Short-dated yields -- the tenor most sensitive to monetary policy expectations -- have soared roughly 57 basis points since.

Read More: Short-Dated Treasuries Rally as Powell Downplays Larger Hikes

And even as traders backed away from the most-aggressive Fed scenario in the aftermath of Wednesday’s meeting, expectations are still for an extremely hawkish central bank. Officials see raising the federal funds rate to 3.4% by year-end, implying another 175 basis points of tightening. That compares to a median projection in March for 1.9% this year.

That commitment to hiking rates and cooling inflation explains today’s rally, rather than just an oversold bounce, according to LPL Financial’s Quincy Krosby.

“Overall the overarching message to the market was we’re fighting inflation, we’re going to just fight inflation until we see those numbers moving in the right direction, that we don’t have any surprises to the upside,” the chief equity strategist said in an interview. “I just think that the market responded to that as clear as can be by actually climbing higher.”

Even though stocks look cheaper on many measures, that hasn’t been a persuasive allure to would-be dip buyers so far. At around 3,800, the S&P 500 trades at about 15.2 times its estimated profits for 2023, toward the low end of its valuation range over the last decade.

And in the eyes of Federated Hermes’s Steve Chiavarone, the valuation drawdown still isn’t a reason to buy.

“Any rally here is an opportunity to reduce risk. A hard landing is now the overwhelming likelihood,” said Chiavarone, senior portfolio manager. “If the market is taking comfort in July potentially being 50 basis points when the Fed is telling us that the fed funds rate will likely approach 4% by early next year, I’d be inclined to take the other side of that.”

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