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Despite the inflation pick-up, the Fed keeps interest rates unchanged, holding them steady between 5.25% and 5.5%, with no sign of rate cuts. Moreover, balance sheet reduction continues as planned, although the Fed expects the pace to slow soon.
It seemed that the market reaction should have been neutral to the news, but we still saw another dose of optimism in the S&P 500 index. Only it is not very clear where it comes from, as no reason for dovishness has been seen in either Powell’s comments or the macro data:
- Economic solid numbers and inflation remaining below target led the Fed to significantly revise its GDP projection for 2024 from 1.4% to 2.0%.
- Even though the Fed chose not to adjust the projection for this year (with three more reductions still pending), they did add rigidity for the coming years.
To be more precise, in 2025, the projection was increased by +0.3 percentage points to 3.9% and in 2026, by +0.2 percentage points to 3.1%. Fed members are beginning to reassess their view of the long-term neutral rate.
But why has there not been a correction when the economic reasons have been evident for some time (problems in regional banks and commercial real estate), and there are many technical reasons, such as profit-taking in technology stocks and especially in AI stocks?
The US stock market is driven by excess liquidity going nowhere. Moreover, its reduction has slowed: from March to December 2023, an average of 6.1 billion dollars a week was withdrawn, but from December until now, only 3.95 billion.
That is, just over 1.5 times less. Another factor supporting the markets is the continued buybacks by companies and, of course, the persistent FOMO by retail investors. As long as the balance of the Federal Reserve Facility has not fallen to zero, all is well.
What to watch out for?
Although the indexes remain on an upward trend, net profits of the largest U.S. non-financial companies fell 9.1% over two years. Overall, excluding technology, profits fell 5.9% year-on-year and plunged 19.2% over two years.
Of course, this alone is not enough to change investor behaviour, but it helps to understand how far stock prices have drifted away from reality. In this regard, following technical indicators, including resistance and support levels, is crucial.
