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How will markets react to September’s Fed rate decision? | Matt Caruso

The US Federal Reserve

The consensus expectation is that the Fed will raise rates by another 75 basis points – but there’s a possibility it could go even further. Caruso Insights’ Matthew Caruso discusses how markets might react.

Stocks continued to slide at the start of this week, as the Federal Open Market Committee (FOMC) kicked off a two-day policy meeting on 20 September that’s expected to end with yet another large rate rise.

Matthew Caruso, the founder of Caruso Insights, doesn’t expect “dramatic moves” in the markets following the anticipated 75 basis-point rise announcement. “A lot has been priced in with that consensus scenario. The natural momentum right now is down – but if [the Fed] comes out with the consensus, I think that will actually be slightly positive.”

The consensus expectation is that, on Wednesday 21 September, the Federal Reserve’s FOMC will announce a 0.75 percentage point rise, which would see the interest rate rise from near zero at the beginning of 2022 to 3-3.25%.

Last week, the S&P 500 had one of its worst weeks of the year, falling 4.8%. It slid a further 1.13% on Tuesday, and the Nasdaq Composite dipped by almost 1%. The two-year US Treasury note, meanwhile, hit a 15-year high of 3.983%, while the 10-year was trading at levels not seen for more than a decade.

Rate hike could create a “stock picker’s market”

If the US central bank does indeed add 0.75% to US rates, this would create a “stock picker’s market”, Caruso says, where broad indices and exchange-traded funds (ETFs) are likely to trend downwards, but a few individual stocks manage to buck the trend.

Stocks that are riding the waves of persistent macro trends and have positive financial indicators, such as strong forward earnings or a healthy pipeline of potential customers, are likely to retain their long-term growth potential. Trends such as the move towards electric vehicles and the push for renewable energy sources could provide interesting opportunities for traders.

Caruso says that he currently has stocks such as Wolfspeed [WOLF] and Tesla [TSLA] on his radar for these reasons. The former is up 5.2% since the start of the month, while the latter has risen 12% as of 20 September.

As well as watching for any decisions the Fed makes today, traders should pay attention to the tone and tenor of the accompanying press conference when deciding how to execute individual trades. “Any discussion by Powell about a more balanced approach given a weakening economy, of a terminal interest rate or a weakening labour market, would be viewed as dovish,” he says. “And given that a lot of people are positioned bearishly, there could be a strong push upwards [in response].”

The movement of treasury notes can provide an indicator of market sentiment. “We just recently broke the June lows on the 10-year treasury,” Caruso points out, adding that a dovish tone from the Fed could push the 10-year yield higher. A fall, on the other hand, “would indicate that the market is starting to believe the economy is weakening, and Powell’s comments may reinforce that.”

“If you see the two-year yield climbing, that means the market has greater conviction in Powell and would be a good indicator into the market’s view on the level of Fed aggressiveness,” Caruso adds.

ETFs based on the major US indices will also be interesting to watch, with the Invesco QQQ Trust [QQQ] mirroring the Nasdaq 100, while the SPDR S&P 500 ETF [SPY] follows the S&P 500.

Could the Fed shock the markets?

There is a possibility that the Fed could raise rates even further, with a small handful of economists believing rates could rise by as much as one percentage point at the upcoming meeting.

This would create an “immediate risk-off” environment, Caruso warns. “It’ll be hard to hide anywhere for upside if that were to happen,” he says, adding that the tech-heavy NASDAQ 100 is likely to plummet in this scenario.

If the Fed were to signal an unexpectedly dovish stance – indicating that aggressive action is likely to be off the table for the near future – this could “force people to get long and play catch-up”, given that many traders have adopted a bearish position.

“The market is already subtly positioning for a more dovish Federal Reserve,” Caruso observes. “Look at high-growth companies that topped in February 2021. A lot of these companies – in software, retail, solar – many of these companies bottomed in May, prior to the market low.”

Since then, their prices have been climbing, Caruso says, pointing to Celsius Holdings [CELH], Chipotle [CMG] and Tesla as examples. As of 20 September, Celsius is up 166.8% since its 52-week low on 10 May, while Tesla has rallied 49.2% since bottoming on 24 May, and Chipotle is trading 42.1% higher than its lowest point on 14 June.

“That’s the equity market not believing the bond market in terms of pricing. We’ll have to find out which market is right,” says Caruso.

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