The US and European equity markets had a strong counterintuitive rally in the month of October. The benchmark indices gained 6 to 15% amidst reports of worsening economic and geopolitical conditions. The benchmark Dow Jones Industrial Average (DJIA) gained 14%, its best monthly gains since January 1976. Of course these gains have come on the back of some of the worst months in history and a pathetic overall performance in the year 2022 so far. Nonetheless, these gains have provided some relief to the embattled investors, keeping the hopes alive.
The latest meeting of the Federal Open Market Committee (FOMC) of the US Federal Reserve is being watched even more intensely, as its outcome tonight is widely expected to determine the market direction from here. One of the largest global brokerage firms J P Morgan Chase & Co. has reportedly stated that “The S&P 500 could surge at least 10% in one day if the central bank raises interest rates by a slower-than-expected half of a percentage point, and Chair Jerome Powell signals willingness at the press conference to tolerate elevated inflation and a tightening labor market”.
Apparently, lots of bets have been placed on softening of the Fed’s stance on monetary tightening. If the Fed disappoints tonight, we may see these bets unwinding; or even changing direction towards a bearish stance. A sharp reversal in the US stock markets might reverberate across markets – USD might strengthen; bonds may weaken; gold and silver may correct; and emerging markets may witness some outflows and hence give up some of the gains made in the past one month.
We shall see the expert engaged in animated discussions over Fed’s strategy and likely outcome. The market economists will term the rather hawkish monetary stance of Fed as totally unwarranted and counterproductive, citing elevated inflation and heated job markets as evidence of the ineffectiveness of the Fed’s aggressive tightening. The macro economists on the other hand would call for even more aggressive policy to completely destroy the menacing inflation and restore the credibility of monetary policy.
We shall also see buzzwords like “imminent housing crash”; “dollar debasement”; “crypto crash”; “deep recession” dominating the headlines in every form of media. A variety of experts will make prophecies about the imminent apocalypse; so that on a later date they could say “I told ya so”.
On the other hand, if the Fed obliges the markets by hiking less than 75bps; or hiking 75bps but hinting that Fed might pause sooner than earlier expected (pivot) – the market might respond as enthusiastically as people at J P Morgan et. al. are expecting. We might see an intense battle as the ‘shorts’ rush to cover and ‘longs’ happily lighten their positions.
Regardless of what Fed does and says, or refrains from doing or saying - few things appear certain:
· The mortgage rates in the US and elsewhere will rise further.
· Putin will maintain its hard stand on Ukraine and Europeans will be paying through teeth this winter to keep their homes warm.
· China will continue to push its agenda of “larger role for China in global order” more aggressively.
· Inflation will come down from a combination of demand destruction and demand transformation (as consumers move to alternative products, methods and technologies). The rate hikes will have a role to play in demand destruction but with a lag. To the contrary the impact of rate hikes on efforts to augment supplies will be visible much earlier. Higher costs would discourage capex, inventory building and debottlenecking; especially when the inflationary expectations are being managed to moderate.
Anyways, I will not stay awake till midnight to hear Mr. Powell. I am also not waiting to hear Mr. Dass tomorrow either, even in the less likely event of him choosing to make a statement post the unscheduled meeting of MPC.
As I understand from the notice of the meeting, this meeting has been called under section 45ZN of the RBI Act. The meeting under this section is called for the limited purpose of discussing and finalizing the contents of the letter to be written to the government explaining the reasons for failing to meet the set inflation targets and enumerate a corrective plan of action. Policy changes are not discussed under section 45ZN. For that a meeting under section 45ZI needs to be called.
However, if the MPC does choose to make an unscheduled hike tomorrow to catch up with the Fed, I may consider a 10-15% underweight on equities for 2023, in my investment strategy, simply because I do not like a central banker who is not in full control of monetary policy and is just managing the spreads with the US Fed.
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