The Fed raised interest rates by 25 basis points yesterday to contain inflationary pressures. The interest hike brings the Fed target rate to 4.50-4.75%. The dot plot suggests a median target range of 5.1%, implying another two rate hikes of 25 basis points in each of the next two FOMC meetings.
The Fed intends to bring inflation down to 2% to achieve price stability. We are not there yet. However, the central bank is committed to bringing down inflationary pressures at any cost. Until the pivot, the financial market will remain volatile as interest rates will likely trend higher. However, beyond 2023, interest rates will likely peak and are projected to fall, suggesting a peak in the inflation rate.
Although the stock market reacted favorably to the FOMC meetings and Powell’s comments, the Job Openings and Labor Turnover (JOLTS) number remains robust, suggesting an increase in December job openings and tight job markets.
They say never bet against the Fed. It is one of the few financial market commandments worth listening to. However, for most of last year, traders and investors have ignored it. Since mid-May 2022, the implied futures pricing of interest rates has accelerated, indicating the markets are focusing more on Fed pivoting than the actual level of interest rates. It suggests investors do not believe the Fed will remain hawkish for much longer and will cut rates next year.
Does Fed have a credibility issue, or are they conveying the wrong message?
Is the market suggesting the Fed is bluffing since the market is trading and focusing on the next easing cycle?
As investors sort this out, it will likely translate into higher market volatility and more rotations within the eleven (11) S&P Sectors.
Relative Rotation Graphs (RRG) can offer a visual view of the 11 S&P sectors, showing leading, improving, lagging, or weakening sectors based on the relative strength and momentum.
In the past few weeks, there has been an increase in the frequencies of the S&P sector rotations.
Many of the leading defensive and commodities-driven sectors from last year have entered into corrective phases, as evidenced by these sectors falling into the Weakening Quadrant (i.e., Energy (XLE), Industrial (XLI), Financials (XLF), Healthcare (XLV), and Consumer Staples (XLP)).
Materials (XLB) is the only S&P sector remaining in the Leading Quadrant. However, its price momentum continues to weaken, suggesting it may soon decline into the Weakening Quadrant.
The underperformers from last year were the growth and cyclical-related sectors, including Communication Services (XLC), Technology (XLK), Real Estate (XLRE), and Consumer Discretionary (XLY). Except for XLY, these sectors have all recovered within the Improving Quadrant. Surprisingly, Utilities (XLU), a classic defensive sector, has quickly soared into the Improving Quadrant.
The Consumer Discretionary Sector (XLY) is the only S&P sector residing in the Lagging Quadrant. However, the relative momentum has dramatically improved over the past few weeks, suggesting it will soon move into the Improving Quadrant.
Are the recent strengths from the growth and economically sensitive sectors indicating investors believe the Fed will engineer a soft landing?
Or are the rotations part of the mean reversion call, resulting in a temporary resurgence of the battered sectors after year-end tax loss selling and window dressing?