Zoom Out to Gain More Perspective on Traders’ Reactions to the Fed

S&P 500 falls -2.5% on Fed rate hike.^[i] That is how most coverage sums up stocks’ volatility on the day the Fed announced it will raise the fed-funds target range by another 0.75 percentage point (or 75 basis points) to 3.75 – 4.0%. Deeper analysis delves into the intraday wiggles, tying every twist and turn to the Fed’s words—and drawing big, forward-looking conclusions. We urge you not to try. There is simply too much noise in ultra short-term moves, which typically have little to do with how markets actually view the foreseeable future.

Initially, when the Fed’s release came out, markets jumped. Live blogs tied that to the following sentence in the Federal Open Market Committee’s (FOMC’s) statement: “In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” Those who parse these things for a living interpreted this to mean the Fed might soon slow its pace of hikes, rendering expectations for the fed-funds rate to top 4.6% next year overwrought. Since many think stocks have paid close attention to terminal rate expectations lately, this was allegedly good news.

But then Fed head Jay Powell launched into his press conference and made numerous statements countering this view, and the more he talked the more markets fell. He warned “the ultimate level of interest rates will be higher than previously expected.” He implied he doesn’t think there is much lag between monetary policy moves and economic activity and claimed “there’s no sense that inflation is coming down” despite what he views as tightening financial conditions, leading him to conclude the Fed has “a ways to go.” The more stocks fell, the more commentators concluded that markets interpreted this forward guidance as a very bad sign indeed.

That is one way to look at it, we guess. But it is also just a little too tidy for our tastes, as it rests on what we think is a very flawed presumption: that everyone buying and selling is doing so with a long time horizon and trading on their mid-to-longer term expectations. In reality, much of the trading at any given moment is the handiwork of, well, traders—people making very short-term moves in hopes of capturing very small spreads. Some will hold positions for seconds, some for minutes, some for hours—and many will choose to be out by the time the market closes, lest they have to face the market moving against big long or short positions at the next day’s wild opening. Many of these people and outfits use technical models to guide their moves—indicators based on historical probabilities about what usually happens in the ultra short term.

So, we would venture that the market movement once the Fed’s statement came out went a little bit more like this: Some traders probably bought because their models told them a fast rally was likely—see data this year—and they hoped to buy low, sell high and capture some of that spread. Then other models flashing sell signals kicked in, and those sells may have outnumbered the people whose models were telling them to buy into an afternoon dip because the low would kick in. Some people likely bought shares to cover short positions. Others probably sold to close out leveraged long positions. Round and round it goes, and some people made money and some people didn’t and then the market closed down on the day. And everyone involved sat back, looked at what happened, counted their winnings and losses, settled with their clearing firms if necessary, then got on with a crisp autumn afternoon to clear their heads before entering tomorrow’s trading frenzy.

Yes, that is all hypothetical, but consider it from another perspective. If you are a long-term investor with a pile of cash on the sidelines and a 30-year time horizon, and you are looking for the perfect entry point, are you really sitting there at 11:03 AM in California thinking, “Oh hey looks like the Fed is going to stop raising rates soon, that clears the way for me to invest this money for the next 30 years, I’m going to buy!”? Or, if you have been in the market all year, weathering stocks’ reaction to inflation, war, political fears, prior rate hikes and all the rest, is there any logical reason that Powell’s comments should suddenly cause you to shift radically? Especially when they didn’t really provide any new and surprising information? Long-term decisions typically don’t rest on such volatile, short-term criteria. Nor is the outlook for stocks over the next 3 – 30 months ever all that likely to hinge on what the Fed says about interest rates on a given day.

In our view, this all plays into Ben Graham’s classic observation that the market behaves like a voting machine in the short term and a weighing machine in the long term. Every short-term wiggle stems from the combined action of all traders and investors. That is, the people buying for 30 seconds or 30 minutes and the people buying for 30 months or 30 years. It will often defy basic logic and expectations. Yet in the longer run, all of that short-term noise tends to even out, and the market’s opinion of fundamental conditions emerges. The wiggles fade into a trend. Trends fade into cycles. Then it becomes possible to make sense of the market’s movement and draw conclusions.

But trying to find deep, meaningful insight in about two hours’ worth of market movement after a Fed announcement? We think your time is better spent elsewhere.