Powell’s Battle-Ready Fed Gives The Trump Trade A Stress Test

The recent speech by Jerome Powell following the FOMC meeting has shifted the market focus back to inflation and the expected interest rate cuts by the Federal Reserve. The support for this decision was nearly unanimous, indicating a strong consensus among policymakers.

Just a month ago, the financial markets were buzzing about Donald Trump and his plans for the US economy, which were thought to boost growth in the coming years. However, as the holiday season approaches, Jerome Powell has re-emerged as a significant influence in the market.

Powell's recent hawkish comments have reignited concerns about inflation, leading to considerable volatility in stocks and bonds, marking some of the most significant market movements since last November's elections. On Wednesday, Powell indicated a reduced interest in cutting rates, resulting in a sharp decline in both markets. Fortunately, the mood shifted two days later when new data on inflation suggested prices were rising more slowly than expected, prompting a rally that eased some losses.

The extent of this market volatility can be attributed to investors' strong bets that the Trump trade will continue benefiting riskier assets. According to a report by Bank of America Corp., allocations to US equities reached record highs while cash reserves have dwindled dramatically. Systematic investors, such as those utilizing volatility-controlled strategies, are also increasing their stock holdings.

This recent activity serves as a reminder that while Trump's policies have fueled optimism, the direction of inflation, combined with Powell's response, remains a critical factor influencing the market. Even with the uptick in stock prices on Friday, the S&P 500 experienced a roughly 2% decline over the previous week.

Market analyst Sameer Samana from Wells Fargo noted that many investors had mistakenly believed the Federal Reserve would continue to lower interest rates regardless of economic conditions. He pointed out the disappointment felt when the Fed acknowledged the persistent nature of inflation.

As the last remnants of the Trump trade resurface, investors must contend with rising bond yields, which have recently surged to their highest levels in seven months. This increase is largely due to waning expectations for interest rate cuts following Powell's comments during the Fed meeting, suggesting that officials are now anticipating fewer cuts due to persistent inflation.

On Wednesday, Powell's moderately hawkish tone led to the S&P 500 experiencing its most significant drop on a scheduled Fed meeting day since 2001. The Fed Chairman expressed that further progress on inflation is necessary before the bank considers easing rates.

US Dollar Performance and Market Reactions

The Federal Reserve's stance, coupled with the dynamics of the Trump trade, has propelled the US dollar to its best quarterly performance since 2016. Signs of market fatigue can be seen across various speculative assets. Bitcoin, often associated with the enthusiasm around Trump, dropped below $100,000, leading to significant declines in related stocks like MicroStrategy Inc.

There were also declines in closed-end funds connected to private companies and outflows from exchange-traded funds like the ARK Innovation ETF following the Fed's decisions. Max Gokhman from Franklin Templeton revealed that many investors who predicted a hawkish meeting were taken aback by the Fed's stance. This ongoing tug-of-war between those bullish on economic growth and those fearing untamed inflation poses a challenge for market stability.

The Fed's tightening signifies that investors once delighted by the promises of tax cuts and deregulation must now also weigh the likelihood that inflation remains unchecked, complicating the overall market outlook.

Cross-Asset Volatility and Market Strategies

The uncertainties surrounding inflation and Powell's approach have led to substantial volatility across various asset classes. The VIX, often referred to as Wall Street's fear gauge, soared above 28 on Wednesday—a level not seen since August—but settled back below 20 by Friday. Ten-year Treasury yields marked nine consecutive days of increases, with a notable drop occurring only after the core personal consumption expenditures index showed its smallest monthly increase since May.

In recent weeks, ten-year yields have surged by around 37 basis points, a significant spike, while investment-grade and high-yield bond exchange-traded funds have seen declines. In the cryptocurrency market, Bitcoin faced its worst two-day losses of the quarter even though it remains more than 100% higher than a year ago.

Despite the general market turmoil, some investors are finding opportunities. Alessio de Longis from Invesco Solutions stated that they have maintained positions benefiting from a scenario where stocks underperform bonds or defensive equities outperform them. He feels the exhaustion of the election-related trades is beginning to take effect.

Powell, Inflation, Markets