The odds of a 0.5% rate hike at the Fed meeting on March 22 jumped sharply on Tuesday. There wasn't any new economic news to trigger the reaction, it was solely due to hawkish comments by Fed Chair Jerome Powell. He essentially admitted that inflation is staying stronger than anticipated, and it was a mistake for the Fed to reduce the pace of rate hikes to 0.25%.
The S&P 500 dropped 1.5% on Tuesday as it worked to price in the impact of higher rates, but the question now is whether the market has fully discounted a potential terminal rate that some economists think could hit 6% later this year.
The market has been battling the Fed for much of 2023 based on two theories. The first was a Goldilocks economic environment in which inflation was not too hot, and growth was not too cold. That has now proven not to be a workable theory. The second recent narrative was that the market could handle higher inflation and interest rates due to the robust economy and strong jobs market. The Fed is undermining that argument by raising rates even more aggressively to gain control of inflation.
Jerome Powell will testify again on Wednesday as the House of Representatives has its opportunity. There are unlikely to be any major new insights, but Powell will reinforce what he said yesterday, which caused the negative reaction.
The economic news shifts to a focus on jobs this morning. There are the ADP employment numbers followed by the JOLTS Job Openings data. JOLTS is closely watched as an indication of any early softness in the employment market.
On Thursday, there are the weekly unemployment claim numbers, and on Friday will be the February employment news. If these numbers stay strong, then the odds of a 0.5% hike at the next meeting will rise again. The CPI and PPI reports next week will likely solidify what the Fed does on March 22, but at this juncture, it is increasingly likely that there will be a 0.5% hike.
The primary technical question now is whether the indexes can find some support fairly fast. The S&P 500 traded back under its 50-day simple moving average but still has support at the lows hit last Thursday morning around 3940. If that level is breached, there is little support down to 3800.
Small-caps have led to the downside over the last two days and are also sitting at 50-day support. However, there have been some pockets of relative strength. Many small-caps and secondary stocks are far more washed out than big-caps and the indexes, and they are more likely to find some support without too much more downside. That doesn't make them good buys, but they may develop better set-ups more quickly than other names.
The bulls have done a nice job this year of ignoring negative economic news and a hawkish Fed, but the news flow is just too negative right now for sustained buying. There still appears to be some decent liquidity, and the zero-day options provide intraday juice, but the argument that the market has fully discounted the economic chaos that lies ahead is extremely hard to justify.
We have a quiet start on Wednesday morning, but the JOLTS report will be a market mover, and Powell is unlikely to bring much cheer.