Stocks Struggle for Traction as Markets Play ‘Game of Chicken’ with Fed on Higher-for-Longer Interest Rates

Stocks Struggle for Traction as Markets Play ‘Game of Chicken’ with Fed on Higher-for-Longer Interest Rates

In the midst of a tug-of-war between financial markets and the Federal Reserve, stocks are struggling to find traction as the market plays a “game of chicken” with the Fed on higher-for-longer interest rates. Despite positive economic data indicating a robust U.S. economy, traders remain skeptical about the Fed’s ability to maintain its stance on interest rates. Fed funds futures traders continue to show a strong likelihood of no Fed action by December and an increased chance of a rate cut by May. Meanwhile, Treasury yields have remained relatively unchanged or slightly lower, signaling a disconnect between market expectations and the Fed’s position. This dislocation is causing volatility and a game of chicken between the market and the Fed as traders wrestle with diverging expectations and growing concerns about inflation and geopolitical risks.

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Introduction

In the world of stocks and financial markets, there is currently a struggle for traction as the markets and the Federal Reserve play a “game of chicken” with regards to higher-for-longer interest rates. This article will explore the expectation gap between the markets and the Federal Reserve, analyze the dislocation in market expectations, and discuss the convergence between the market and the Federal Reserve. Additionally, key levels to watch for stocks and bond yields will be identified.

Expectation Gap between Markets and the Federal Reserve

Data Points to Strong U.S. Economy

Recent data suggests that the U.S. economy is still experiencing significant momentum. Third-quarter U.S. economic growth and the monthly headline PCE inflation for September have both exceeded expectations. Despite these positive indicators, traders in the fed funds futures market still believe that there is a 78.6% likelihood of no Fed action by December.

Traders Doubt the Fed’s Higher-for-Longer Theme on Interest Rates

Traders in the market have expressed doubts about the Federal Reserve’s commitment to the higher-for-longer theme on interest rates. This divergence in expectations between the market and the Fed is not uncommon, as traders often rely on the possibility of a U.S. recession to cool inflation. However, the current situation is made more complicated by the ongoing war in the Middle East, which raises the risk of an oil shock, and the slow progress of inflation towards the Fed’s 2% target.

Fed Funds Futures Show Likelihood of No Fed Action by December

The fed funds futures market indicates a high probability of no action by the Federal Reserve in terms of interest rates by December. Traders in this market have also increased the likelihood of a rate cut by May. This suggests that the market is expecting the Fed to change its stance and begin cutting rates, but the Federal Reserve has remained steadfast and has not indicated any plans for rate cuts.

Rate Cut Chances Boosted for May

Traders have increased the chances of a rate cut by May, further highlighting the expectation gap between the market and the Federal Reserve. This increase in rate cut expectations may be driven by concerns over a potential recession or inflation victory, both of which the Federal Reserve has not yet experienced.

Treasury Yields Finish Little Changed

Despite the expectation gap, treasury yields finished little changed, with the policy-sensitive 2-year rate reaching a two-week low. This suggests that the bond market is not fully buying into the market’s expectations of rate cuts. The movement in treasury yields is an important indicator to watch for the overall direction of interest rates.

Market and Fed Divergence Not Uncommon

Divergence in expectations between the market and the Federal Reserve is not uncommon. This divergence often results in volatility in the markets as traders and investors try to navigate the uncertainty. The current situation is no different, with both the market and the Federal Reserve playing a “game of chicken” in terms of higher-for-longer interest rates.

Occurring Amidst Middle East War and Inflation Risks

The divergence in expectations is occurring against the backdrop of a war in the Middle East, which raises the risk of an oil shock. Additionally, there are concerns about inflation not reaching the Fed’s target of 2%. These factors add further complexity to the market’s expectations and the Federal Reserve’s position on interest rates.

Fed’s GDP Now Estimate Points to Fourth Quarter Growth

The Atlanta Fed’s GDP Now estimate is pointing to a 2.3% growth rate for the fourth quarter. This estimate suggests that the U.S. economy is still on a path of steady growth, which may influence the Federal Reserve’s decision on interest rates in the future.

PCE Price Index Shows Higher Inflation than Expected

The PCE price index, the Fed’s favorite inflation gauge, showed a greater-than-expected increase in the headline inflation rate for September. This increase in inflation is cause for concern, as it suggests that inflation may be picking up more quickly than anticipated. It is important to monitor inflation trends as they can have a significant impact on interest rates and the overall economy.

Monthly Core Inflation Still Below Fed’s Target

Although the headline inflation rate showed higher-than-expected inflation, the monthly core inflation rate is still below the Federal Reserve’s target of 2%. This indicates that inflation may still have some room to grow before the Federal Reserve takes action on interest rates.

Stocks React to PCE Report

Following the release of the PCE report, U.S. stocks finished mostly lower. The Dow Jones Industrial Average fell over 1% and the S&P 500 entered correction territory, down 10% from its recent peak. The reaction of stocks to the PCE report highlights the market’s sensitivity to inflation and interest rate expectations.

Key Levels to Watch for Stocks and Bond Yields

In order to gauge the direction of stocks and bond yields, it is important to monitor key levels. For stocks, the S&P 500 needs to regain the 4,200 level in order to improve sentiment. Additionally, the 4,050 level is seen as a key retracement level and is expected to provide support for stocks. As for bond yields, stability or a meaningful pullback is needed for equities to gain traction. The 10-year yield reaching a peak level of 5.022% indicates that the market is still uncertain about the long-term rate.

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Dislocation in Market Expectations

Gap Between Market and Fed Signals Volatility

The expectation gap between the market and the Federal Reserve is leading to increased volatility in the markets. As traders and investors try to navigate the uncertainty, there may be significant swings in stock prices and bond yields. This volatility can create opportunities for those who are able to accurately predict market movements.

Game of Chicken Between Market and Fed

The current situation can be described as a “game of chicken” between the market and the Federal Reserve. The market is expecting the Federal Reserve to change its stance and begin cutting rates, while the Federal Reserve has remained steadfast in its commitment to higher-for-longer interest rates. This game of chicken creates uncertainty and can further contribute to market volatility.

Market Expects Fed Rate Cuts, but Fed Stays Hawkish

Despite market expectations of rate cuts, the Federal Reserve has maintained a hawkish stance on interest rates. This divergence in expectations can be attributed to the market’s reliance on a potential U.S. recession to cool inflation, while the Federal Reserve is still waiting for either a recession or an inflation victory before taking action on rates.

Policy Makers Have Not Suggested Rate Cuts

Policy makers within the Federal Reserve have not suggested rate cuts, further adding to the dislocation in market expectations. The Federal Reserve’s consistent messaging on higher-for-longer interest rates raises questions about whether the market’s expectations will eventually align with the Federal Reserve’s stance.

Fed Still Awaiting Recession or Inflation Victory

The Federal Reserve is still waiting for either a recession or an inflation victory before making any changes to interest rates. The lack of either of these events has contributed to the dislocation between the market and the Federal Reserve. Until there is more clarity on the direction of the economy, it is likely that this dislocation will persist.

Fed’s Consistency Raises Questions for the Market

The Federal Reserve’s consistent messaging on higher-for-longer interest rates raises questions for the market. If the Federal Reserve does not deviate from its current stance, it will be interesting to see how the market reacts and adjusts its expectations. The market will need to evaluate whether its expectations are realistic or if they need to align more closely with the Federal Reserve’s outlook.

Analyzing Market and Fed Convergence

Factors to Consider for Convergence

There are several factors to consider when analyzing the convergence between the market and the Federal Reserve. These factors include economic indicators, inflation trends, geopolitical events, and the Federal Reserve’s messaging on interest rates. By closely monitoring these factors, it is possible to gain insight into whether the market and the Federal Reserve will eventually converge on interest rate expectations.

Market Expectations versus Fed Statements

Analyzing the gap between market expectations and the Federal Reserve’s statements is crucial for understanding the current situation. By comparing market expectations for rate cuts and the Federal Reserve’s hawkish stance, it is possible to identify the source of the dislocation and potential drivers for convergence in the future.

Effects of Middle East War and Inflation on Convergence

The ongoing war in the Middle East and the potential for an oil shock can significantly influence the convergence between the market and the Federal Reserve. Additionally, the pace of inflation and its impact on interest rates will also play a role in determining whether the market and the Federal Reserve will eventually align their expectations.

GDP Now Estimate and Fourth Quarter Growth

The Atlanta Fed’s GDP Now estimate points to a 2.3% growth rate for the fourth quarter. This estimate suggests that the U.S. economy is still on track for steady growth, which may influence the Federal Reserve’s decision on interest rates. Monitoring the GDP Now estimate can help identify potential areas of convergence between the market and the Federal Reserve.

PCE Price Index and Inflation Concerns

The PCE price index, the Fed’s favorite inflation gauge, showed higher-than-expected inflation for September. This increase in inflation raises concerns about whether the Federal Reserve will need to take action on interest rates in the future. Analyzing the PCE price index and its impact on inflation expectations can provide insight into potential convergence between the market and the Federal Reserve.

Impact of PCE Report on Stock Performance

The reaction of stocks to the PCE report highlights the market’s sensitivity to inflation and interest rate expectations. Monitoring stock performance following the release of important economic reports, such as the PCE report, can provide a gauge of market sentiment and its alignment with the Federal Reserve’s stance on interest rates.

Key Levels and Significance for Stocks and Bond Yields

Identifying key levels for stocks and bond yields is essential for understanding their significance and potential impact on market expectations. These levels can serve as support or resistance points and can help determine the overall direction of stocks and bond yields. By monitoring these levels, it is possible to gain insight into potential convergence between the market and the Federal Reserve.

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Conclusion

The struggle for traction in the stock market as the market and the Federal Reserve play a “game of chicken” with higher-for-longer interest rates is creating volatility and uncertainty. The expectation gap between the market and the Federal Reserve is influenced by economic indicators, inflation trends, geopolitical events, and the Federal Reserve’s messaging on interest rates. By closely analyzing these factors and monitoring key levels for stocks and bond yields, it is possible to gain insight into potential convergence between the market and the Federal Reserve. As the situation continues to evolve, it will be important for traders and investors to stay informed and adapt their strategies accordingly.

References

• Stocks to struggle for traction as markets play ‘game of chicken’ with Fed on higher-for-longer interest rates (source: MarketWatch)

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