Wall Street Defers Big Bets During Fed Countdown

Investors who had previously anticipated the Federal Reserve to initiate rate cuts this week are reluctantly accepting a scenario of prolonged elevated rates. Treasury yields stabilized following a recent decline, during which traders postponed their expectations for policy adjustments. Equities inched upwards as the "Magnificent Seven" group of technology behemoths, often dubbed the "most-crowded trade" in equities, rebounded from session lows.

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"Investor caution prevails ahead of this week’s meeting, where the Fed might lean towards a slightly hawkish stance following recent persistent inflation data," commented Craig Johnson of Piper Sandler.

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The S&P 500 hovered around 5,160 points. Microsoft Corp. and Apple Inc. saw gains, while Nvidia Corp.'s highly anticipated new chips failed to fuel further increases following an almost 80% surge in shares this year. Treasury yields experienced a slight uptick, while the yen weakened as the Bank of Japan refrained from indicating future rate hikes after abandoning the world's last negative interest rate policy.

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With the Fed anticipated to maintain rates for the fifth consecutive meeting on Wednesday, attention will focus on the central bank's projections in the "dot plot."

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The economic projections summary will reveal whether robust data are prompting officials to reconsider rate cut plans or if their outlook for three reductions this year remains intact.

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"Whether the increase in yields and the strength of the dollar can persist largely hinges on whether the Fed confirms the hawkish narrative," observed Win Thin and Elias Haddad at Brown Brothers Harriman. They added, "If Jerome Powell adheres to the hawkish stance, the message will remain consistent and market reaction will likely be subdued. However, if he deviates from the script and adopts a dovish stance, the market reaction is expected to be more pronounced."

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Mark Cabana of Bank of America suggested that if the Fed's dots indicate only two cuts in 2024, the two-year note would experience a 10 basis point sell-off, the dollar would rally, and risk assets would face some pressure. Conversely, if the dots suggest three cuts — BofA's base case — the two-year note would rally five basis points, the dollar would weaken, and risk assets would fare better.

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The Fed will also initiate in-depth discussions regarding its balance sheet this week, including the timing and method of reducing the pace at which excess cash is withdrawn from the financial system.

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Since 2022, the Fed has allowed up to $60 billion in Treasuries and up to $35 billion in agency-backed mortgage debt to mature monthly and roll off its balance sheet, a process known as quantitative tightening.

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"In our opinion, discussions regarding the Fed's balance sheet plans will be as significant as discussions about the potential timing of rate cuts," stated Chris Senyek of Wolfe Research. He added, "Although we don't anticipate an official announcement regarding QT tapering until the May meeting, we anticipate insights into the potential timing and pace of the reduction."

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The Fed has indicated a preference for ultimately returning to a Treasury-only portfolio, suggesting the MBS runoff pace will persist, although the Fed may be more flexible in extending the timeline, slowing QT, according to Naomi Fink of Nikko Asset Management.

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"There's also a bias toward coupon securities, indicating that over time, the Fed may need to increase its T-bill holdings relative to coupon holdings, which, all else equal, suggests diminished support for the long end of the curve," noted Fink.

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Goldman Sachs Group Inc. strategists suggest that investors should view stock market dips as buying opportunities, given the macroeconomic backdrop of robust growth and ongoing inflation normalization.

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"While equity momentum has somewhat bolstered broader risk appetite, we see limited implications of a continued reversal unless there's a significant US rate shock," wrote a team led by Christian Mueller-Glissmann.

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Bullish positioning for US equities softened last week, according to Citigroup strategists led by Chris Montagu. Although positioning for the S&P 500 and Nasdaq remains net long — albeit moderately extended — the current setup suggests reduced positioning risks for both indexes, they observed.

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The debate on Wall Street regarding whether the meteoric rise of the US stock market has been too rapid or excessive is so intense that even Bank of America's own strategists hold conflicting views.

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According to BofA's Savita Subramanian, there is little evidence to suggest that the artificial intelligence frenzy is pushing the market towards bubble territory. Her perspective contradicts the opinion expressed by the firm's chief investment strategist, Michael Hartnett, last week.

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"There's no widespread euphoria," Subramanian stated in a joint interview with Jill Carey Hall, BofA's head of small- and mid-cap strategy on Bloomberg Television. She added, "The risks lie outside the public market," highlighting private credit, private equity, and regional banks as areas where credit risks are surfacing.

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