It will be a holiday-shortened trading week, but it won’t be short on news events. The massive news event will come on Wednesday at 2 PM with the release of the November Fed minutes. The minute will likely reverse The celebration of the equity market after a lower-than-expected October CPI report, as the Fed has a different view and is already pushing back hard.
Since the release of the CPI report on November 10, Fed-speak has been crystal clear – slower rate hikes do not mean a lower terminal rate, and one better-than-expected CPI report is not going to change the course of monetary policy. Finally, the speakers seem to think that rates are even higher.
St. Lewis Fed Governor James Bullard suggested dovish assumptions about monetary policy were justified after rate hikes.
The November FOMC statement indicated the likelihood of a slower pace of rate hikes coming, while the FOMC press conference indicated that the terminal rate is likely to be higher than previously expected in September. Since the FOMC meeting, many FOMC members have laid out a strong case for the overnight rate to rise above 5% and potentially to 5.25% in 2023.
If the message of higher rates is correctly conveyed in the FOMC minutes, it seems more likely than not that the equity market rally since the October CPI report in mid-November should not only pause but reverse.
In addition, the VIX should rise sharply at the FOMC meeting on December 14. 2023.
In fact, throughout 2022, there has been a pattern of the VIX rising or falling at the FOMC meeting following the market’s perception of the Fed minutes. Currently, the VIX is trading towards the lower end of its trading range, around 23. The last time the VIX was this low in the release of the FOMC minutes came back on August 17, which also marked the end of the August rally and was followed by a sharp rise in the VIX and a very sharp decline in the S&P 500. The same thing happened in early April, which also marked the end of the March rally, and early January, which marked the market peak .
Rates and the dollar
The bond market is already anticipating more hawkish commentary from the Fed minutes to be released this week. Fed funds rates again call for the top rate to be above 5% and back to levels immediately following the November FOMC meeting. In addition, the peak rate is now seen in July instead of May, incorporating smaller rate hikes.
The view of higher rates also helped lift the 2-year yield, moving it back above 4.5%, and stopped the bleeding of the dollar index. These are crucial signs that the bond and currency markets are listening to what the FOMC members are saying and taking the call for higher rates very seriously. The Fed minutes should carry out the opinion of the Fed officials and should only help to push the dollar and rates even higher.
Higher rates and a strong dollar should help tighten financial conditions, pushing stock prices lower and increasing implied volatility levels.
Fall back plan
Just in case the market does not respond appropriately to the minute. The Fed is taking no chances at the FOMC meeting this time and will ensure there will be no mix-ups from a potential article cap heading into the December meeting. There will be no repeat of the October version of The Davis Pivot.
This time Jay Powell will take matters into his own hands and speak for an hour at the Brookings Institute on November 30, starting at 1:30 PM ET. The conversation is even more critical because it will come one day before the official FOMC blackout period begins at the December 14 FOMC meeting. It will be Powell’s chance to make sure the market doesn’t go off course in the next two weeks.
The Fed has told the market all year that it intends to raise rates aggressively and wanted financial conditions to tighten. Yes, there were countertrend meetings along the way, but if one thing is clear, the Fed was committed to higher rates. If the minutes don’t deliver that message this week, Powell will be sure to do on Nov. 30 what he did on Aug. 26 in Jackson Hole, put the hammer down on the equity market again.