Fed’s mixed messages prompt market whipsaws
James Chen, CMT February 21, 2018 4:31 PM
The heavily anticipated minutes from the last FOMC meeting in late January, when interest rates were kept unchanged as expected, were released on Wednesday afternoon. Prior to the release, markets were expecting the minutes to take on greater market-moving significance than would normally be the case, as the recent equity market correction has been attributed in large part to increased concerns over rising inflation and interest rates. In the immediate aftermath of the release, markets were indeed moved – and in wildly diverging directions – as investors speculated on the Fed’s somewhat mixed messages.
The minutes from January’s FOMC meeting revealed Fed officials’ acknowledgement of rising economic growth and inflation, as well as continuing strength in the labor market. Inflation was seen as likely to reach the central bank’s 2% target over the medium-term. In addition, as a result of “upside risks” for economic growth that Fed officials forecasted due to recent tax reform legislation and other factors, economic projections initially made in December were revised higher in January.
For these reasons, Fed officials confirmed that tighter monetary policy and higher interest rates would likely be necessary and appropriate. However, the minutes continued to stress a “gradual” approach to policy tightening, and did not sound any alarm bells about surging or overheating inflation. Markets had been fearing a potentially accelerated rise in inflation after recent wage growth and consumer price inflation data came out significantly higher than expected.
Prior to Wednesday’s release of the FOMC minutes, stock indexes had been moving sharply higher as bond yields and the US dollar had both pulled back moderately. Immediately after the release, these market moves were extended, as investors initially saw the minutes leaning slightly more to the dovish side, due in part to the Fed’s repeated focus on a gradual approach to higher interest rates. As markets digested the hawkish aspects of the release, however, markets reversed course. The dollar quickly surged as US government bond yields hit new multi-year highs. US stocks gave up all of the sharp gains from earlier in the day to slip back significantly into negative territory by the end of the trading day, with volatility still elevated from the market’s recent gyrations.
The wild market whipsaws that were seen after the Fed’s release of minutes suggest that heightened market volatility is likely here to stay, at least for the time being. With investors continuing to worry over rising inflation and interest rates, the unusually complacent markets of 2017 may well be a thing of the past.
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