The Fed pulls back from the aggressive talk

Risk assets and bonds all rose as risk sentiment improved

Published in

TRACKRECORD DAILY

7 min readMay 5, 2022

With the market fearing the worst, the US Federal Reserve’s interest rate hike of 0.50%, the start of balance sheet reduction and the promise of the possibility of more 0.50% hikes in the “next couple of meetings” provided a much-needed boost of relief for investors.

As we wrote yesterday, the market was priced for a more aggressive outcome, and though the Fed’s action was strong and it voiced its commitment to expeditiously move interest rates to more neutral levels, it was not as aggressive as the market has priced.

As a result, risk assets and bonds all rose as risk sentiment improved and fears of a Fed hiking without regard to the economic consequences ebbed.

For now, the market has been issued a reprieve and the recent lows will be support levels going forward. If inflation should start to eased off the highs, this rally could start to gain momentum.

TRADING TIP

A Lesson In Trends

If something works (in this case as reflected in asset pricing) and you don’t understand why, chances are that it’s smarter than you and you just haven’t figured it out. This is the kind of intellectual humility that is required to go far in trading and life, because the world does not only revolve around our own historical experience but takes into account what has happened everywhere collectively.

Humility is important because there is no such thing as real “objectivity” in our analysis. No matter how we try, there are still innate biases in our opinions due to our own interactions with the world. Hence, to overcome this innate bias, we have to respect the market when it starts to move against us.

This is critical for trading success as this will stop us from losing everything on a trade that we have very strong convictions about but yet, keeps bleeding money.

DAY AHEAD

The Bank of England is expected to hike its policy interest rates by 0.25% to 1.00% and the Monetary Policy Report could be dovish given the recent weakness in economic outlook.

TRADING PLAN

1. Currencies:

EUR — Short the EUR. EUR rallied as the market was relieved by the US Federal Reserve interest rate hike and comments that were not as aggressive as feared. Stay short and look to add to short.

2. Commodities: Uranium & Energy — Stay the course.

3. Stocks:

US Stock Index: The US stock market rallied hard on the Fed’s policy decision. The lows of recent days will likely be strong support levels going forward.

Single Stocks: TrackRecord Model Portfolio is tracking the broader market for now.

Key risks: US Federal Reserve policymakers’ comments will dictate how the market perceives future policy path for now. The Ukraine-Russia war rages on, but the market impact is limited for now.

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WHAT HAPPENED YESTERDAY

Market Movement As of New York Close 4 May 2022

The Federal Reserve committee raised interest rates by 0.50% as expected, its most aggressive move so far in its fight against inflation. The Fed also indicated that it will begin reducing its $9 trillion balance sheet. Beginning Jun 1, the Fed will roll off $30 billion of Treasuries and $17.5 billion of mortgage-backed securities (MBS). After 3 months, the cap will double to $60 billion and $35 billion respectively. These numbers are in line with the minutes of the last Fed meeting.
In his press conference, Fed Chairman Powell reiterated the Fed’s commitment to “expeditiously bring inflation back down”, citing the burden it has on the lower-income group. He also implied multiple +0.50% rate hikes ahead with nothing more aggressive than that. He also noted that while economic activity slowed down in the first quarter, household spending and business investment remains strong.
Although the Fed’s policy action was aggressive, it was not as aggressive as the market feared. Powell downplayed the possibility of a 0.75% hike, saying it’s not something being “actively mulled”. The vote to hike by 0.50% was unanimous, meaning even the most hawkish member, Bullard, who was openly talking about a 0.75% hike for this meeting, voted for a 0.50%. This was a huge relief to the market and bonds, stocks and cryptos all rallied in response.
The US 2 year Treasury Bond yield fell -0.12% while the 10 year yield fell -0.04% with Powell’s comments that the Fed will not be more aggressive than the current +0.50% hikes.
The US stock market welcomed the comments from Powell of not being aggressive than what is already priced while ensuring a soft landing. The S&P 500 climbed +2.99%, the Dow Jones Index increased by +2.81% while the Nasdaq roared higher by +3.41%. The stock market rally is the biggest one day rise on a Fed policy meeting day in a decade.
The crypto market traded well along with the US stock markets as risk sentiment became strongly positive. Bitcoin rose +5.8% just shy of the 40,000 level while Ether increased +5.7% to 2,940.

HEADLINES & MARKET IMPACT

EU proposes gradual ban on Russian oil in sixth round of sanctions against Moscow

Notable Snippet: The European Commission, the executive arm of the EU, on Wednesday put forward new sanctions against the Kremlin, which will include a six-month phase out of Russian crude imports.

The ban had been a highly controversial topic within the EU, but the move gained more momentum after Germany backed the idea. Two EU nations — Slovakia and Hungary which are both highly dependent on Russian energy — have been demanding exemptions.

Von der Leyen chose not to give any details on exemptions during her speech, but three EU officials, who did not want to be named due to the sensitive nature of the issue, confirmed to CNBC that the commission’s proposal includes this flexibility — giving Hungary and Slovakia a longer period of time to phase out Russian oil.

Two of the anonymous officials said that both nations will have until the end of 2023 to halt Russian oil imports.

Speaking Wednesday, von der Leyen explained that the six-month phase-out period for most EU nations would give time for commodity markets to adjust.

WHAT WE THINK: The EU seems to be advancing well in its quest to sanction Russia to aid Ukraine. The trend higher in energy prices is getting stronger.

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From Estee Lauder to Apple, big companies say China’s Covid restrictions are hitting business

Notable Snippet: Starbucks said Tuesday same-store sales in China fell by 23% in the quarter ended April 3 from the same quarter last year. That’s far worse than the 0.2% increase analysts expected, according to FactSet.

“Conditions in China are such that we have virtually no ability to predict our performance in China in the back half of the year,” interim CEO Howard Schultz said on an earnings call, noting additional uncertainty from inflation and the company’s investment plans.

Despite nearly all its final assembly plants in Shanghai restarting production, Apple said the lockdowns would likely hit sales in the current quarter by $4 billion to $8 billion — “substantially” more than in the last quarter. The other factor is the ongoing chip shortage, management said on an April 28 earnings call.

WHAT WE THINK: China’s zero Covid policy is starting to hit multinational companies’ bottom lines as well. It is likely we will see a hit on earnings of major companies given how huge the consumer market is in China.

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Biden to talk with G7 leaders this week about further sanctions on Russia

Notable Snippet: U.S. Treasury Secretary Janet Yellen said the United States was in constant discussions with its partners about further sanctions and could take “additional actions” to pressure Moscow.

At a Wall Street Journal conference, Yellen would not preview any specific actions under consideration, but stressed that further measures were likely “if Russia continues this war against Ukraine.”

Biden told reporters, “We’re always open to additional sanctions” when asked about U.S. plans after the European Union proposed its toughest sanctions yet against Russia, including a phased oil embargo.

“I’ll be speaking with the members of the G7 this week about what we’re going to do or not do,” Biden added.

The White House declined to say when Biden would speak with the leaders of the other G7 countries — Britain, France, Germany, Japan, Canada and Italy.

WHAT WE THINK: With more concerted efforts to hurt Russia economically, we may either see a de-escalation by Russia as its war efforts start to go down the drain or a dramatic “all-or-nothing” call by Putin.

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