Daily Market Comment – Dollar cools off, stocks rally as Fed signals slower hikes

  • Fed raises rates by 75bps but Powell opens the door for a slowdown 
  • Dollar takes a step back, gold bounces, stock markets go into overdrive
  • Meta earnings disappoint, show continues with Apple and Amazon today
Fed turns cautious

As widely expected, the Federal Reserve raised interest rates by 75 basis points for the second straight month, frontloading the tightening of monetary policy. Chairman Powell noted that interest rates have now reached ‘neutral’ levels and will need to go into restrictive territory to cool the economy enough for the inflationary fire to be extinguished. 

The twist was that the Fed opened the door for a slowdown in the pace of rate increases. Powell made it clear that the Committee will be data dependent moving forward, make its decisions on a meeting-by-meeting basis, and won’t provide clear guidance on what happens next. His tone gave the sense that future rate increases won’t be quite so forceful. 

Market participants wasted no time, with the implied probability for another 75bp move in September declining substantially in the aftermath and the terminal rate being marked down a notch. This translated into a softer US dollar and a relief rally in the stock market, with the Nasdaq that is most sensitive to rate fluctuations climbing by more than 4% to record its strongest session in two years. 

Overall, traders have started to sense that the Fed is getting cold feet now that economic momentum is losing steam. However, this is not sufficient to derail the uptrend in the dollar. Every other major currency is grappling with its own demons and if the Fed ultimately slows down because of recession concerns, safe haven flows could keep coming the dollar’s way. 

Gold bounces, yen powers up

With the mighty US dollar finally taking a step back and real yields losing altitude once the Fed dust settled, gold is back in vogue. The yellow metal suffered heavy damage this month but seems to have found some solace in the Fed’s signal that the speed of rate increases might be toned down. 

The Japanese yen was another winner. It managed to capitalize the most on the dollar’s pullback, drawing power from the retreat in yields as rate differentials finally narrowed to its benefit. That said, it’s still difficult to envision a trend reversal so long as the Bank of Japan remains committed to keeping a ceiling on domestic yields and elevated energy prices keep the nation’s trade balance in deficit. 

GDP report and earnings

As for today, all eyes will be on the preliminary GDP report for Q2 from the United States. The forecast from economists is for annualized growth of 0.5%, yet the Atlanta Fed GDPNow model points to a contraction of 1.2%. This model has been fairly accurate in the past and if it is proven correct, this would mark the second quarter of negative growth, putting the economy in a technical recession. 

The White House and even the Fed chief have downplayed this prospect lately, arguing that the economy is still in good shape with strong underlying demand and a healthy jobs market. No matter how you spin it though, a contracting economy is never good news. The funny part is that it might be good news for stock markets, if it makes traders more confident that the Fed will back off. 

Meta Platforms reported disappointing earnings yesterday. Revenue fell from a year ago and the company provided a gloomy forecast for this quarter, citing a weakening environment for advertising. The earnings show will continue today with Apple and Amazon, and the stakes couldn’t be higher as both companies are trading at a substantial valuation premium to the overall market. 

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