US financial markets started the week in unpleasant fashion as stocks and Treasury notes sold off rapidly. The Dow has fallen over 800 points intraday; the S&P 500 is likewise down over 3%, or over 20% from its January high, with its transformation into a bear market being actualized. Treasuries briefly experienced a yield curve inversion as the yield on the 2-year note exceeded that of the 10-year note, an indication of impending recession, while yields for both securities reach decade-long highs. Meanwhile, DXY crossed above the 105 level as demand for USD grows before the Federal Open Market Committee’s (FOMC) rate hike decision on Wednesday afternoon. In preparation for Wednesday’s volatility, let’s discuss what the FOMC decision could mean.

Possibility #1: Market Expectations Met

Most analysts are currently anticipating a 50 basis point (bps) rate hike for the federal funds rate on Wednesday, which would put the target interest rate at 1.5%. However, potentially more impactful than the rate hike itself will be the FOMC press conference afterwards, and what details about future hikes Chairman Jerome Powell opts to reveal to the public as inflation and recession concerns mount. Given the importance of his comments, 50 bps hike expectations being met may not matter to the markets in light of the set of new expectations he generates.

Possibility #2: More Hawkish Than Expected

This could take at least two forms, such as a) an aggressive 75 bps increase to the federal funds rate on Wednesday, which some analysts are speculating, and/or b) Powell hinting at even further accelerated hawkishness to quell hyperinflation concerns. With this past Friday’s reveal of year-over-year US inflation being at 8.6% and considering the Federal Reserve’s consistently hawkish disposition in recent months, these could be plausible. This would signal continued bullishness for USD and bearishness for stocks.  

Possibility #3: More Dovish Than Expected

This could similarly take at least two forms, including a) a mild 25 bps increase to the federal funds rate on Wednesday, which few analysts seem to be speculating, and/or b) Powell hinting at a return to dovishness to mitigate recession fears. With companies and investors facing plummeting share prices, coupled with Powell’s original comfort erring on the side of protecting employment over staving off inflation, this may be more possible than many think. This would signal a sudden departure from USD bullishness and would likely restore demand for stocks.

Key Takeaways

• With both recession and continued hyperinflation fears rearing their heads and damaging the US economy, the Federal Reserve will have to tread carefully as they implement a rate hike on Wednesday and signal their plans going forward.
• Possibility #1 is that the FOMC’s Wednesday rate hike is the 50 bps expected, which may not matter as the markets could instead digest Powell’s hints about future hikes.
• Possibility #2 is that the Federal Reserve displays even more hawkishness with a focus on slowing hyperinflation, which would likely be a catalyst for more buying pressure for USD and more selling pressure for stocks due to tightening monetary policy.
• Possibility #3 is that the Federal Reserve reverts to dovishness to address recession concerns, which would likely be a catalyst for abrupt selling pressure for USD and restored buying pressure for stocks due to contractionary fears (temporarily) subsiding.