IUSV - Fed Preview: A Growth Scare May Alter The FOMC's Plans IUSG In Focus

2023-03-21 12:23:18 ET

Summary

• Growth had its best week against value more than two decades earlier this month amid a steep fall in Treasury yields.
• A quarter-point rate hike is expected, but there's still a material chance of a "no-hike" outcome.
• The bond market should brace for more volatility while equity investors must monitor trends in the growth vs. value trade.

What a difference six weeks makes. Back in February, investors were laser focused on what any small ebbs and flows in inflation indicated. From CPI data to jobs reports to ISM prices paid levels, an inkling that consumer price trends could be moderating was seen as a real positive, and Fed Chair Powell even cited disinflationary pressures during this most recent press conference.

CPI Rate Moving in the Right Direction, But Much Work for the Fed to Do

Fast forward to today, and fears of a global financial crisis have both bond and stock traders on edge. The VIX rests under 30, but the ICE BofA MOVE Index, which gauges volatility in the rates market, notched its highest level since late 2008 at times last week following turmoil domestically with Silicon Valley Bank ( SIVB ) and Signature Bank ( SBNY ) having to be put into receivership by regulators.

Then came the Credit Suisse saga. A swift collapse in confidence and a forced takeover by UBS, essentially a bailout by the Swiss government, kept traders glued to their screens this past weekend. Global central banks then coordinated to offer further backstops to markets last Sunday.

A 15-Year High in Treasury Volatility

That brings us to this week’s Fed meeting. There’s still uncertainty as to what the FOMC will decide. As it stands, traders have priced in a high likelihood of a small quarter-point hike Wednesday afternoon. With no further financial shoes dropping in the last 36 hours, the chance of a "no hike" outcome has dropped from 26% to 18%.

Traders Expect a 0.25ppt Hike, But Not A Slam Dunk

The FOMC members’ dot plots are due at 2 p.m. ET tomorrow. Goldman Sachs expects the median dot to show a slightly higher peak funds rate for this year compared to the last survey done in December 2022. But a more spread-out plot should be anticipated given still-high inflation coupled with an emerging growth scare. Keep your eyes on dissenters from the Fed decision.

Dot Plot Expectations: A Bigger Spread, High Uncertainty

Making the Fed’s job more touchy is that the risk-off trade has been in full force this month. In fact, just last week, growth had its best stretch against the value style since 2001. What makes that a major risk-off move is that it’s the result of Treasury yields falling sharply amid a massive flight to quality. The way intermarket dynamics are working right now, when rates fall, long-duration growth equities do much better than cyclical value areas.

Banks, of course, are perhaps the most value-oriented niche with regional banks being the most cyclical of the bunch. If the Fed offers guidance that it sees financial markets as being resilient while lifting the policy rate a quarter point, I could see a situation where rates increase further – not out of inflation fears, but out of confidence that the economy may re-find its footing. In that scenario, the Financials sector could continue to snap back (as it has done so far this week).

Growth's Best Week Against Value Amid Banking Sector Turmoil

If, however, the Fed signals that more emergency measures may be needed, investors may ask themselves, “What does the Fed know that we don’t?” And value could give back its gains on the week. So, this is a much different FOMC gathering compared to previous instances. And with the MOVE Index still at a historically extreme level, the final two hours of trading Wednesday could be quite wild in the bond market.

What will I be watching? The growth vs value trade (no surprise). The iShares Core S&P U.S. Growth ETF ( IUSG ) seeks to track the investment results of an index composed of large- and mid-capitalization U.S. equities that exhibit growth characteristics, according to iShares. A key trend is how IUSG performs relative to its value counterpart, IUSV, which tracks domestic core value companies. The growth vs. value chart below illustrates that the former gave back nearly all relative gains versus the latter dating back to late 2019.

The big question here is if value has more left in the tank, or if growth is ready to continue its 2023 trend of alpha. Technically, I could see more retracement higher in the relative move, but ultimately value is in the poll position on the multi-year timeframe. Certainly, if value snaps back, and fresh lows since 2018-19 are made, that will confirm that a long-term cycle in favor of cyclical vs long-duration equities should persist.

Core Growth vs Core Value: Holding 2018-19 Lows

The Bottom Line

This week’s Fed decision comes after the banking sector has been rattled by several shocking events. As conditions appear to be easing, the next volatility catalyst will likely come Wednesday afternoon from the Fed’s rate decision, dot plot, and press conference. Expect volume to be high, particularly in the fixed-income markets.

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