Investors Knew Rate Hike Was Coming, Then Sold it Anyway

It was no secret that the Federal Reserve was likely to announce a quarter-point hike on Wednesday afternoon, but the hawkish tone was a surprise and the news was sold anyway.

The Fed raised rates to a range of 3.75% to 4.00%, the first hike since 2023, and the market took a hit. There was a late bounce that helped but the Dow fell 1.2%, small caps dropped 0.5%, and breadth was abysmal at 36% positive with 350 new lows against 90 new highs.

The quarter-point hike was not the problem. The problem was that all the elements of the decision were more hawkish than the market had wanted to hear.

More Hawkish Than Anticipated

Three things made this hawkish, and none of them was the hike itself. The vote was unanimous. I said on Wednesday morning that if the Fed hiked, the dissents would likely come from the doves, and instead every member voted for it. A unanimous hike tells us the committee is far more united behind tightening than anyone thought, which removes the hope that the doves would rein chair Kevin Warsh in.

The dot-plot was the second surprise. Four members projected another 50 basis points of hikes this year, and only two saw the current levels as adequate. The median now points to at least one more hike before the end of the year, most likely in December. The market wanted one and done. It got a signal that this is the start of a series.

Third was Warsh himself. He vowed a “timelier return” to 2% inflation, which is about as hawkish as you can be without using the word “hawkish.” The FOMC statement called economic activity solid and domestic spending resilient, which eliminates the argument that the economy is too fragile to tighten. Warsh is telling the market he intends to bring inflation down faster rather than wait for the supply shocks to fade, which means that further hikes are on the table.

Exactly the Outcome I Was Watching For

On Wednesday morning I wrote that I would not trust post-Fed strength and that any pop would get sold. We did not even get the pop. The market took one look at a unanimous hike, hawkish dots, and Warsh promising a faster return to target, and sold it immediately.

The bond market has been telling us for weeks that rates were going higher, and today the Fed confirmed it in the clearest terms. The question all week was whether this was one hike or the first of a series, and the answer came back as a series. There is no ambiguity left to hope on.

The problem now is that we have some ugly looking price action as the indices undercut recent lows. There is little support out there and few potential positive catalysts on the horizon. The likelihood isn’t that we will be bailed out by a positive surprise. The likelihood is that we are going to fall further before some bargain hunters help create support.

Game Plan

Nothing about my approach changes. I did not chase anything into the decision and I am not going to chase the selling out of it either. A sharp down day on a hawkish Fed is not the washout that creates the setups I want. It is the market repricing to a higher rate path, and that repricing may take more than one session.

What I am watching now is the bond market. If the 10-year pushes decisively through 5% from here, the pressure on stocks continues regardless of how oversold they get. If yields stabilize now that the Fed has removed the uncertainty, that is the first thing that would let equities find a floor. Either way, the decision that has been hanging over this market for a month is finally behind us, and that is worth something even on a day this ugly.

The good news is that the shopping list is long and the names on it are getting cheaper. The opportunities are improving although the existing positions are painful. I am in no hurry to put precious capital to work, but after today I have one less thing to wait on.

Have a good evening. I’ll see you tomorrow.

At the time of publication, DePorre had no positions in any securities mentioned.