Stock Market Sell-off Indicates Investors Were Anticipating Fed Pivot

Sellers hit the U.S. stock market last week as aggressive longs liquidated positions after Fed policymakers delivered a surprisingly hawkish message in its policy statement and Fed Chairman Jerome Powell provided more bearish ammunition with his hawkish tone.

The price action in the benchmark S&P 500 Index suggested investors were caught off-guard by the Fed and had no choice but to bail out and regroup while assessing exactly what the Fed was saying.

Prior to the release of the Fed’s monetary policy statement and Powell’s stern warnings about inflation and rate hikes, stocks were on the upswing. That mini buying spree was fueled by what investors thought was a softer tone from the central bank and Powell.

Perhaps they misheard the Fed or failed to read Powell correctly, but for some reason, investors went into the Fed meeting heavily long as if they believed the Fed was about to announce its hugely desired pivot in policy.

Investors May Have Misread Powell’s Tone in his November 30 Speech

In his Nov. 30 speech, Federal Reserve Chairman Jerome Powell confirmed that smaller interest rate increases were likely ahead even as he saw progress in the fight against inflation as largely inadequate.

Powell’s speech came on the heels of recent statements from other central bank officials and comments at the November Fed meeting that saw the central bank in position to reduce the size of rate hikes as soon as next month.

In addition to his softer tone about rate hikes, however, Powell cautioned that monetary policy is likely to stay restrictive for some time until real signs of progress emerge on inflation.

Powell may have fooled investors into thinking the Fed was ready to pivot when he said, “It makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down.” He also added, “The time for moderating the pace of rate increases may come as soon as the December meeting.”

At that time, Wall Street applauded the remarks. The Dow Jones Industrial Average closed up 737 points, or 2.18%. Tech stocks fared even better, with the NASDAQ Composite roaring 4.41% higher.

Investors and Fed Not on the Same Page

The current sell-off isn’t signaling a resumption of the bear market in my opinion, but rather the liquidation of aggressive positions bought in anticipation of a Fed pivot. When the Fed didn’t pivot last week and announced a higher than expected terminal rate instead, investors had no choice but to bail out.

What the misinterpretation of Powell likely means is that the market believes the Fed is too bearish. Investors want to believe that inflation is going down and the Fed is closer to ending its rate hike campaign.

However, the Fed wants to knock down everything in its way including job growth, inflation and stock prices. This supports the case for a sideways or rangebound trade in the stock market until investors get more clarity from the Fed and can invest with more conviction.