Not too hot, not too cold Fed meeting boosts the market’s mood

The much-anticipated Fed meeting arrived, and it didn’t disappoint. After a turbulent week for financial markets the prospect of a dovish Fed soothed the markets on Wednesday, with stock markets rising across the board, Treasury yields falling back, and safe haven flows into the dollar and the yen moderating slightly. There is still a lot of risk out there, but even if the Fed does decide to start tapering its asset purchases in November, this week’s meeting suggests that the core of the committee remains broadly dovish on the path for interest rates, which is why stocks actually rose after the announcement and remain higher on the day. Overall, this meeting did not give us any new information to digest: we are headed down the path of tapering, which was expected, and interest rate increases will be incremental after that. 

The Fed’s economic forecasts 

The backdrop to Wednesday’s meeting was bad for risk, with stock indices experiencing their worst month for returns since March 2020. The Evergrande crisis in China, rising inflation concerns in Europe due to soaring energy prices and rising Delta infections in the US undermining economic growth all took their toll. However, the bulls in the market (and who isn’t a bull these days), were soothed by the Fed’s Jerome Powell who sounded fairly at ease about the outlook for economic growth in the world’s largest economy. The Fed’s latest economic projections dramatically cut back economic growth expectations for 2021 to 5.9%, down from 7% in June. However, growth in 2022 and 2023 was revised up to 3.8% for next year compared with 3.3% in June. Inflation is also expected to rise, with the Fed’s preferred measure of inflation, the core rate of price increases, expected to rise to 3.7% this year compared to a 3% forecast in June, before prices fall back sharply to 2.3% in 2022. 

NFPs: no need for blockbuster jobs growth 

Ensuring the US economy has full employment is another part of the Fed’s dual mandate along with ensuring inflation is under control. Even after August’s disappointing payrolls report, the Fed remains relatively optimistic on the outlook for employment, with Jerome Powell saying that it would not require a blockbuster September jobs number for the Fed to start scaling back its asset purchases later this year. He said that for him it would take “a reasonably good employment report for me to feel like that test is met.” Thus, although there are weak patches in the US economic picture right now, and even though there were some big changes to the Fed’s economic projections, the Fed remains committed to tightening monetary policy, which is a vote of confidence in the US economic outlook. 

Blue chips still have the edge on smaller stocks 

How does this translate to asset prices in the near to medium term? We have said that we remain wary about further gains for the major stock markets in the US and parts of Europe due to high valuations and the weakening technical signals that suggests a sell off could be coming. We have seen some analyst downgrades for Q3 earnings in recent weeks, and we think that a poor earnings season could see stocks sell off as we progress through October and into November. However, the Fed’s economic projections have given us food for thought. Unless a company is currently experiencing a negative shock from the supply chain crunch that we are witnessing around the world, then we think that large, diversified companies, think big blue chips on the S&P 500,s should continue to do well. After all, even though the Fed has revised lower its economic forecast for growth this year, the US economy is still expected to expand by 5.9%, which is a strong rate of growth historically. Thus, at this stage of the stock market rally, where technical indicators are starting to give way and Q3 earnings season is fast approaching, we prefer to steer away from sectors that are vulnerable to the supple chain crunch. We also prefer large, blue chip stocks that diversified income streams relative to small cap stocks. Thus, we prefer the S&P 500 over the Russell 2000 in the US. Likewise, we prefer the FTSE 100 in the UK above the FTSE 250 or FTSE 350. 

US interest rates: not too slow, not too fast 

Regarding the future path for US interest rates, Wednesday’s FOMC meeting gave us two new developments. FOMC members now see 3 interest rate hikes in 2023, compared with 2 in June. There are also 9 FOMC members who predict that the first rate rise will take place next year, up from 7 in June. The FOMC is now split about when the first rate rise will happen, with 9 members expecting rates to rise next year and 9 expecting the first rate rise to come later than 2022. It is interesting that even though the Fed’s US economic forecasts were cut, interest rate expectations shifted to the hawkish side. However, we continue to think that the outcome of this meeting is market friendly because: 1, the pace of interest rate increases is still not particularly fast, and 2, it is another sign of the Fed’s confidence in the US economic outlook even with the current challenges, which is good news for global growth. 

BOE outlook 

Thus, as we progress through to the end of the week, we expect the dollar to come under some moderate selling pressure and for stocks to try to recoup some of their losses from earlier this month. September could still throw up some more surprises, and seasonally it tends to be a bad month for returns in risk markets. However, the Fed meeting was the key event this month, and with that behind us it could be time to wipe the slate clean. The Bank of England meeting on Thursday is not expected to throw up any surprises, but now that the Fed and the ECB have indicated that tapering is coming then we could see the BOE join this group, thus a slightly hawkish tilt at this week’s meeting could be on the cards, although we think that the BOE will join the Fed and wait until its November meeting to make any big announcements about its asset purchase programme. We will be watching the outlook for UK growth closely, especially after some weak economic data in the summer months. 

GBP outlook and why the FTSE 100 is looking good 

Overall, the BOE meeting is unlikely to weigh too heavily on the FTSE 100, which is being driven higher by takeover talk along with stronger commodity prices. Entain, the owner of Ladbrokes and Coral, received a $20bn takeover from DraftKings, the US sports betting firm, earlier this week, which is the latest in a series of swoops on UK businesses from their US rivals. This caused Entain’s share price to surge another 5% on Wednesday. One has to wonder what will happen to the UK index once all of these takeovers have taken place, but for now, takeover talk is buoying the FTSE 100 and protecting it from the downturn in the utility sector, which is coming under immense pressure after the price of natural gas has pushed 8 of the UK’s smallest electricity providers into bankruptcy this week. Overall, the pound could take the flack if the BOE is notably dovish compared to the Fed and the ECB on Thursday. GBP/USD is close to a one month low and has failed to benefit from subdued dollar action post the Fed meeting, which is a bad sign for GBP bulls as we lead up to the BOE meeting. GBP/USD remains in striking distance of the $1.36 lows, if this level is breached, then the GBP bears need to beware of YTD lows around $1.3570, which could act as a key pivot point for traders. If this level is breached, it would be a very negative signal for GBP, however, we would expect this level to be defended, at least in the short-term.