Sell in May and Go Away?

Macro Markets

Today at 2 pm, we have the US Fed Reserve meeting. The Fed will announce its decision on interest rates. Fed Chief Powell is expected to hike rates by 25 bps to take the Federal Funds Rate range to 5% to 5.25%, the highest level since 2007. However, we must see how dovish Powell will sound during the commentary following the rate decision. The stock market and all risk assets, like Crypto, will focus on guidance from the Fed for the future path of rates. We may see a large rally in the market if the market sees a pause by the Fed in its subsequent meeting in June. However, any hawkish signals from the Fed may give negative surprises to the markets. A pivot could historically move the market, and we see a sell-off.

Given the fresh volatility in regional banks and a 7% decline in the KRE regional bank ETF on Tuesday, the market is still deciding about a Federal Reserve rate hike on Wednesday. The market is pricing in that the Federal Reserve will deliver one more quarter-point hike on Wednesday before a lengthy pause. Australia just had a surprise hike after saying pause, so anything on the horizon is possible. The implied odds have fallen to 86%, but that would still be a major surprise, and holding rates might be seen as a sign of non-confidence in banks, a warning that the Fed knows something the market does not. The market could sell off if they don’t hike due to fear.

The real question for the Fed is what to signal next. A hawkish hike is almost certainly on the table, given the backdrop, and a fall in job openings on Monday highlighted the progress the FOMC wants to see on a cooling economy. GDP has dropped as well. We're also approaching the terminal top in rates, so some change in tone is warranted. Powell hinted at a high level of uncertainty on how much the banking crisis might restrain lending, but some Fed officials have pegged the baseline at 25 bps. I think the latest round of trouble adds upside to that number and tells the Fed that if it pushes much further, we could have a larger problem that's much harder to contain and would require a rapid series of rate cuts. In addition, the Fed should start to see the pain in commercial real estate as another avenue for looming tightening.

At the moment, the Fed may fear damage to its inflation-fighting credibility by explicitly highlighting a pause. Still, it could go back to the 2006 playbook with the removal of “additional policy firming,” highlighting that inflation risks remain and that the Fed is data-dependent. A further dovish move will be if Powell doesn't push back hard against market pricing, showing cuts late in the year. He might do this by highlighting uncertainty and offering dovish hints noting that US inflation should fall below 4% or even 3.5% by mid-year.

U.S. Treasury Secretary Janet Yellen has warned that the U.S. government could default on some of its payments by June 1 if the debt limit is not increased. Reports said President Biden is calling congressional leaders to the White House to discuss the matter. This news may have put a slight bid into the safe-haven gold market.