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Dovish Fed pushes stocks higher

18 March 2021

Federal Reserve Chair Jerome Powell hammered home the message that the US central bank will not be rushed into raising US interest rates, despite green shoots of an economic recovery. It’s been a point that Powell had reiterated on multiple occasions already. This time, markets began to pay more heed.

The Fed’s dovish message prompted risk assets to move higher:

The S&P 500 and the Dow posted new record highs respectively, with the latter closing above the psychologically-important 33,000 level for the first time ever. Meanwhile, the tech-heavy Nasdaq 100 notched 3 consecutive days of gains to remain close to its 50-day simple moving average.

At the time of writing, the futures contracts for all 3 major benchmark indices are in the green, suggesting more gains are in store if this sentiment until the Thursday US cash session open, and beyond.

Risk appetite should also stay buoyed, thanks to the Fed’s positive revisions to its economic forecasts:

What’s changed with the Fed’s policy?

In the past, policymakers would try and pre-empt surging inflation by raising interest rates to prevent consumer prices from roaring higher. Then, after a policy review, the Fed announced in August last year that the central bank is now willing to tolerate an inflation overshoot.

Yet, up until recently, markets were of the opinion that the trillions of dollars spent supporting the US economy would result in more inflationary pressures that would force the Fed to act sooner than expected. Judging by the market action in the latest US session, investors and traders are now getting a better handle on the Fed’s messaging which insists that policymakers would not act until there are more concrete signs that a full economic recovery is in sight.

Two doesn’t a tantrum make

There was however a notable change in the number of Fed officials who now see a liftoff in US interest rates sometime in 2023. During the December FOMC meeting, five of 17 officials held that opinion. Yesterday, that figure went up to seven of 18. The majority of Fed officials still believe that interest rates should remain near-zero at least through 2023.

That shift in those two FOMC members wasn’t enough to roil risk appetite, with market participants now interpreting this as a clearer runway for risk assets to climb higher, potentially through all of 2022.

Powell remains untroubled by bond yields surge

The yields on 10-year Treasuries had surged to its highest levels since January 2020, even breaching the 1.68% mark temporarily before the Fed’s announcement only to have eased off slightly since. Despite the wild movements in yields in recent months, Powell took the opportunity to stress that the Fed’s current asset-purchasing programme, which stands at US$120 billion per month since the pandemic took hold, is at the “right place”.

Note that those rising yields on the back of heightened inflation expectations had prompted a selloff from more expensive tech stocks, even pushing the Nasdaq into a brief correction (10% drop from recent high). That also pushed investors into rotating funds into other sectors that are catching up since the pandemic, such as energy and financial stocks, the top two performing sectors on the S&P 500 so far this year.

To be clear, further upticks in Treasury yields are only to be expected moving forward, as yields continue recovering from historic lows. But as long as Treasuries act in a calm and orderly manner, and market participants don’t see an obvious need to challenge the Fed’s commitment towards maintaining its ultra-loose policy settings, that would contribute greatly towards a conducive environment for more stock gains.



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