Stocks have now posted back-to-back weekly gains mostly thanks to an aggressively dovish shift in Fed policy expectations (again) following last week’s Fed decision that signaled an imminent end to the rate hiking cycle. I still believe the Fed will increase rates an additional .75% before July. Volatility remained elevated in the past week, driven by heavy price action in the banking sector amid shaky confidence in the global financial system.
Last week, we pointed out four catalysts for the week and the outcomes of those catalysts were mixed. First, bank stocks fell to new 52-week lows amid conflicting commentary out of Yellen regarding deposit insurance. Despite a bounce on Friday, the heavy price action in banks remains a headwind for stocks and will be until the sector shows meaningful signs of stabilizing.
The second was deposit insurance. Initially, reports that U.S. officials were exploring ways to increase FDIC insurance limits was well received. Then Yellen pushed back on that idea Wednesday afternoon. The Treasury Secretary then changed course again on Thursday and Friday, but ultimately there was no material progress towards higher deposit insurance coverage and that uncertainty will remain a headwind for risk assets in the near term.
Third, the Fed decision was received positively as rates markets aggressively priced in not only an end to the rate hiking cycle, but also multiple rate cuts by year-end. The fact that the Fed left the door open to more rate hikes if data warrants was a fairly overlooked negative component of the Fed decision leaving the catalyst an only mild positive for markets. Finally, geopolitical tensions between the U.S. and China regarding Russia never really flared up while Trump was not arrested as many expected. That left geopolitics to be a limited influence on the markets last week.
Bottom line, a Fed pause is positive for stocks and other risk assets but the familiar, rapid repricing of less hawkish policy expectations presents the risk of another major disappointment from Powell and Co. It now will take just one hot inflation print to pin the Fed between a proverbial “rock and a hard place,” as policy makers would face the decision of either continuing the fight against inflation with aggressive policy or risk sending the global financial system into another crisis. So, despite two consecutive weekly gains in the broader equity markets, I maintain a cautious stance favoring defensive sectors. Additionally, with banks hitting new 52-week lows last week, we can’t rule out more headwinds from the financial sector as confidence in the system remains low and notably fragile.
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