Hawkish Pause or Skip: Wall Street Awaits Fed's Impact on Markets

June 11, 2023

Wall Street refers to it as a "hawkish pause" or a "hawkish skip." This refers to the belief that the Federal Reserve could have a hawkish impact on markets even without raising interest rates at the conclusion of its two-day policy meeting on Wednesday.

There are concerns that such an outcome could lead to a reversal in U.S. stocks, particularly if the May inflation data, expected to be released on Tuesday, shows an uncomfortably strong reading. This scenario could push the central bank towards more extreme actions, such as raising rates on Wednesday, despite previously signaling an intention to abstain.

Economists predict that the May consumer price index will increase by 4.0% for the year, lower than the previous rise of 4.9%. The core index, which excludes food and energy prices, is expected to rise by 5.3%, down from 5.5%.

On the other hand, if there are signs of economic weakness and fading inflation, it would provide justification for the Fed to skip a rate increase in June, as several senior officials have suggested. However, this would also signal that the potential rate hike at the next meeting in July could be the last increase in the current cycle.

The upcoming Wednesday meeting is crucial for the market, as U.S. stocks have been performing strongly for over six months, with the S&P 500 rising more than 20% since its low on October 12, according to FactSet. Just last week, the index exited bear-market territory for the first time in a year.

In 2023, the index has already increased by 12%, partially recovering from its 19.4% decline in 2022, which was its largest drop since 2008, based on Dow Jones Market Data.

So far this year, technology stocks have been driving the market, compensating for weakness in other areas. However, this trend has started to shift in the past two weeks, with small-cap and value stocks suddenly surging. There are concerns that the Fed's actions could negatively impact technology stocks, which are sensitive to interest rate changes, if Chairman Jerome Powell hints at higher rates than what investors currently expect.

Notably, a group of technology stocks, including Alphabet Inc. (GOOG, GOOGL), Microsoft Corp. (MSFT), Tesla Inc. (TSLA), Netflix Inc. (NFLX), Nvidia Corp. (NVDA), and Meta Platforms Inc. (META), have been responsible for most of the S&P 500's gains this year, as noted by Ed Yardeni, president of Yardeni Research.

Since the beginning of June, the Russell 2000, which measures small-cap stocks in the U.S., has risen by over 6.6%, according to FactSet data. The Russell 1000 Value Index has also gained nearly 3.7% during this time. Both have outperformed the tech-heavy Nasdaq Composite, although the Nasdaq remains the market leader, with a 26.7% increase since the beginning of the year.

Concerns about the Fed's plans heightened after the Bank of Canada unexpectedly raised interest rates, ending a four-month pause. This move followed a similar action by the Reserve Bank of Australia. Consequently, U.S. Treasury yields increased and technology stocks tumbled, resulting in the Nasdaq experiencing its largest drop since April 25, according to FactSet.

While small-cap stocks held up during this market chaos, the reaction raised concerns that a similar situation could occur when the Fed announces its latest decision on interest rates on Wednesday.