Who’s afraid of a hawkish Federal Reserve? Apparently not stock-market investors, who sent the Dow Jones Industrial Average up more than 500 points on the day after an initial dip into negative territory after the central bank delivered a well-expected quarter-point rate hike.
Indeed, it was a day of big swings across major assets, including Treasurys and the U.S. dollar, as the Fed penciled in the equivalent of quarter-point rate increases at each of its remaining meetings this year. In the end, investor appetite for risky assets like stocks appeared intact, while demand was lacking for traditional havens, like Treasurys and the U.S. dollar.
While the Fed’s statement and economic projections were initially viewed as skewed more to the hawkish end of the spectrum, there weren’t any extraordinary measures. That made for more of a “business as usual” approach to kicking off the rate-hike cycle, said Ross Mayfield, investment strategy analyst at Baird, in a phone interview.
“Picking how the market is going to react in those situations is tricky,” he said.
Here’s a look at how stocks and other important assets performed:
The Dow DJIA, +1.55%, which was trading with a gain north of 200 points when the Fed’s policy announcement hit the tape, initially dipped into negative territory. The S&P 500 SPX, +2.24% and Nasdaq Composite COMP, +3.77% trimmed gains. But the pressure didn’t last long, with major indexes recovering during Powell’s news conference and gaining steam in the final minutes of trading.
The Fed’s rate move, which was telegraphed with unusual detail by Powell a few weeks ago in congressional testimony, also comes after a stock-market slide that had already seen the Dow and S&P 500 enter correction territory, each dropping more than 10% from early January highs, while the Nasdaq had entered a bear market, dropping more than 20% from its November record finish.
Expect investors to remain glued to developments around Russia’s invasion of Ukraine, which sent indexes to 2022 intraday lows in late February.
“Certainly the near-term catalyst is any development in Ukraine,” Mayfield said, because it’s tied to the economic outlook. Progress toward a cessation of fighting would be a boon to Fed policy makers because it would help bring oil prices down.
Coming consumer-price index readings will also be important. While the Fed has laid out a hawkish timeline, investors will be jittery about any upside inflation surprises that stirs talk of an outsize half-point rate increase or an intermeeting move, Mayfield said.
Treasury yields, which move the opposite direction of prices, surged higher following the Fed announcement, then trimmed their rise as they continued to trade at levels last seen in 2019.
The Fed’s hawkish tilt ensured that yields on shorter-dated maturities, which are more sensitive to near-term central bank expectations, rose the most. That resulted in a flattening of the yield curve, a line plotting yields across all maturities. The spread between 2- TMUBMUSD02Y, 1.930% and 10-year note TMUBMUSD10Y, 2.173% yields narrowed to less than 25 basis points, around its flattest since March 2020, according to FactSet. Meanwhile, the 5-year rate rose above the 10-year yield, inverting that part of the curve.
Investors keep a close eye on the 2- vs. 10-year part of the curve. Inversions of that measure of the curve have a record as precursors to recessions. With the Fed penciling in an aggressive series of rate increases, some strategists see scope for an inversion to occur in a matter of months.
“Given risks to outlook to both the upside and the downside, the combination of policy makers aiming to become restrictive and remaining overly optimistic about the growth outlook seems like a recipe for the Treasury curve to remain flat,” said Alex Pelle, U.S. economist at Mizuho, in a note.
While Powell “seemed to concede that the Fed made an error in waiting so long to remove policy accommodation despite high inflation, our view that the probability of another policy error and growth mishap going forward has increased,” he wrote.
And then there was the dollar. While the greenback popped higher on the statement, it soon gave up gains. The ICE U.S. Dollar Index DXY, -0.21%, a measure of the currency against a basket of six major rivals, was down 0.7% in late afternoon trade, failing to build on the Fed’s hawkish tilt or the jump in short-term Treasury yields, which would typically be supportive of the currency.
It may have been another case of buy the rumor, sell the fact, analysts said. The index last week rose to its highest level since May 2020, buoyed in part by haven-related buying tied to war-related jitters.
A sharp upward revision to the Fed’s so-called dot plot of interest rate projections was a likely catalyst for the dollar’s initial jump, said Matthew Ryan, senior market analyst at Ebury, in emailed comments.
“The median dot now shows seven rate hikes in 2022, up sharply on the three penciled in back in December and more than the five that we had anticipated,” he wrote. “This hawkish turn in the dot plot can largely explain the move higher in the dollar, although with the market already pricing in seven hikes this year prior to the meeting, the rally in the greenback has so far been rather fleeting.”