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Fed fights back with huge hike


  • Fed hikes rates by 75 basis points, the first time since the 1990s.
  • Equity markets reacted positively to the news as all main indices rallied.
  • Is this the bottom or just a brief relief rally for equities?

The Fed pulled the emergency brake on Wednesday as it hiked rates by a significant 75 basis points, the largest one-day increase in interest rates since 1994. The surge in inflation and strong employment market meant the Fed felt it had the power to utilize such a significant move to try and catch up to the inflation curve. It has been behind this curve for two years now as the “inflation is transitory” phrase finally was ditched earlier this year.

We remain unconvinced by both Wednesday’s price action and the sudden pivot by the Fed. The track record of the Fed both historically and recently does not lend much confidence. This Fed under Powell has been a pump merchant and now it appears to be engineering the dump. Previous Fed boards have not exactly set the world alight either with the irrational exuberance of the ’90s leading to the spectacular DotCom collapse. The Fed usually fails to engineer a soft landing to cool inflation, so why should this time be any different? We are currently assuming the US enters a recession in 2023. In fact, the latest GDP Now estimate from the Atlanta Fed shows that the US may already be in a recession.

Recall that a recession is defined as two consecutive quarters of negative economic growth. Last quarter, US GDP growth registered a fall of 1.5%. Economists wrote this off as a one-off surprise due to the Omicron wave in early 2022, import strength as retailers piled up on inventory and inflation hitting home. Well, that one-off looks like it is about to become a trend based on the chart below. 

SPY ETF News: Analysts are way way too bullish

With Q1 earnings season now past and the next season about a month or so away, we took stock of the current EPS forecasts from the Wall Street analyst investment community. Wall Street analysts represent one of the most optimistic cohorts of society. Not surprising really, given high pay rates and the dominance of bull markets throughout history. Being bullish is usually correct. This does, however, make analyst forecasts ahead of and during recessions way off course, and this time it looks like more of the same. 

Current EPS forecasts for the S&P 500 are for growth of just over 1%. This looks optimistic given the mounting headwinds for the global economy. Supply chains are still a mess, inflation is still raging, and consumer demand and sentiment are turning decidedly lower. The Fed is now back on point, and monetary conditions are tightening at an unfamiliar rate. Add in the strong dollar, which always hurts US earnings, and you have the recipe for some serious downward revisions next quarter we believe.

What all this means is that in the longer term this bear market has more time to run before it bottoms out. We feel the next quarter could see a shock with numerous EPS misses and lower guidance. That may be the washout, but it could also extend into H2 as rate hikes continue to bite. However, with the market being forward-looking, we are likely to reach the bottom nine months before the real economy bottoms out.

SPY stock forecast

From a short term view, the SPY has now broken cleanly the $380 Fibonacci retracement (38.2%). This cements the bearish trend. The remainder of this week and next are likely to see more selling pressure as longer-term investors adjust portfolios in response to the latest Fed move. We already note this morning’s total reversal of Wednesday’s relief rally. As we approach the end of next week though, the upcoming quarter-end flows (which look considerably positive) could be supportive for equities. With sentiment currently at extreme bear levels, we may have an upcoming bear market rally on our hands. We do have some obvious gaps at $390 and then $401 to fill. $415 remains a key resistance. Before then though $360 as the high from September 2020 looks likely. 

SPY chart, daily

 


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