A Hawkish Hike Pushes The Stock Market Lower

Fed Raises Rates Like Expected

The Fed raised rates 20 basis points like the market expected. However, the unexpected part was the change to guidance. This is a situation where a small change made a big difference. The Fed went from 6 officials thinking there should be 3 hikes this year and 6 Fed members thinking there should be 4 hikes to 7 thinking there should be 4 hikes and 5 thinking there should be 3 hikes. Only one out 12 officials changed his mind; this was a very small change in guidance which is having big impact on the markets. As you can see in the chart below, the dot plots have changed. The fact that one policy maker expects rates to be cut by 2020 and two expect rates to be above 4% in 2020 show how wide the swath of thinking is. Luckily policy changes usually don’t rely on one member because relying it is a precarious situation.

(Click on image to enlarge)

Hawkish Hike

The impact was already felt on Wednesday’s market as traders decided this was a hawkish hike. Hawkish hikes have been rare in this cycle as the Fed has taken baby steps when hiking rates. Usually the Fed tries to avoid the volatility that comes with higher rates by giving dovish guidance. The problem with that combination is it’s unsustainable. There are only a certain number of hikes which can be taken away while the Fed still hikes rates.

It’s very important for investors to avoid acting in the heat of the moment which is difficult when the action can be volatile on a minute by minute basis. It’s fine to react quickly if you’re only looking at charts, but if you want to process this change in Fed policy, it takes a clear head. The fact that just one member changed his mind means the Fed can easily reverse that decision if the data changes or the stock market sells off.

Did The Rising Stock Market Play A Role?

Policy makers won’t admit that they look at the stock market, but they do. The stock market has risen since the last meeting, so that might have played a role in the guidance change. There’s a possibility that the improved economy in Q2 made a Fed official more hawkish, but the Fed really shouldn’t be making policy decisions based on a couple months of data. There are also increased risks in emerging markets which have sprouted up and a slowing European economy, so I feel that the fundamentals have been neutral. On the other hand, stocks have risen steadily up until Wednesday with momentum bringing the S&P 500 close to a new record. If the Fed follows the market, eventually these rate hikes will cause a correction which will cause it to cut guidance before it even gets to hike rates 2 more times this year.

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