Pardon the interruption. We will be taking a break from our usual earnings week programming to focus on the Federal Reserve ahead of this afternoon’s rate announcement and subsequent press conference. Fed Funds futures are generally predicting a rate hike of 75 basis points, though there is about a 10% chance of a 1% hike priced in by some traders. While there is a general consensus around the level of short-term rates, there is much more uncertainty surrounding what Chairman Powell might say during his press conference.
Will he commit to fighting inflation at any cost, indicate that the Fed’s inflation focus could be sacrificed if economic conditions weaken, take steps to reduce Fed transparency that hampers its ability to surprise markets, or somehow offer something for everyone to like? Don’t discount the last part. We’ve frequently referred to the Chair as “Goldilocks in a Suit” for his ability to thread the needle between investors’ conflicting market opinions.
Besides, investors appear to be in a charitable mood. Yesterday we discussed how the market’s peak probability outcome for Alphabet (GOOG) was in the $111-112 range, and like magic, it’s currently trading at $112 despite headline earnings that missed estimates. Analysts were able to glean the positives underneath the top line. Microsoft also missed and was trading lower in the pre-market, but then we found solace in the company’s outlook that is pushing the stock about 5% higher – well above the modest expectations that appeared to be priced in.
The improving market psychology puts us in a tricky situation. It is clear that equity traders want to look on the bright side of life right now, but that could provide sufficient cover for the Chair to test the market’s resolve. It is reasonable to expect that the Fed has access to an advance look at the second quarter GDP number that will be released tomorrow morning. If the number is more in line with the Atlanta Fed’s GDPNow estimate of -1.2% rather than Bloomberg’s consensus estimate of 0.4%, he may need to do some deft messaging about how the true definition of a recession is when the NBER declares one, not the commonly accepted two consecutive negative quarters of GDP (last quarter was -1.6%). The tell would be whether he shifts to messaging about a shallow recession and/or soft landing rather than downplaying recessionary fears entirely.
Below is a table that we have utilized ahead of various FOMC meetings. It shows the 3-Day change in the S&P 500 (SPX) from the close on the day prior to the meeting through the close two days later. Most meetings are on Wednesdays, so that is typically Tuesday’s close through Friday’s. We see that most periods show a decline, though the average results were drastically improved by the stellar period around March’s meeting.
We have added a new column at the right. That shows the percentage change between the high and low for the relevant three-day period. Few of us trade strictly on a close-to-close basis, so it is important to see the underlying volatility that is often obscured when we look strictly at closing values. All the prior meetings in this calendar year show that we had periods of high volatility whether or not the closing values reflected them.
Finally, the following graph shows that very short-term historical volatility is near its lows for the year coming into today. It graphs 3-day historical volatility, which lines up with the period shown in the table above. FOMC meetings are shown with vertical lines.
3-Day Historical Volatility for SPX, June 1, 2020 – Present, with Vertical Lines at FOMC Meetings
We see that some, but not all the periods around FOMC meetings have been more volatile than average over the past two years. It would be nice to be able to draw an obvious conclusion, such as meetings always bring extra volatility, or that volatility peaks or troughs around meetings, but one does not present itself. It seems reasonable to position for intra-day volatility, but very difficult to say definitively that one should position for higher or lower volatility over the medium term based on the data above.
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