QQQ - Should the Fed surprise the markets with a strategic pause?

2023-04-27 04:53:04 ET

The plunge in shares of First Republic ( FRC ) brought out some betting that the Fed could think twice on a rate hike next week.

First Republic is down 60% for the week and sank 30% on Wednesday as it looked to get larger banks to buy long-dated securities above market value to shore up its balance sheet.

That took the odds of a Fed pause on May 3, based on fed funds futures contracts, above 30% at their peak.

That move indicates there is "still concern among market participants that the turmoil we saw last month could flare back up again" and speaks "to the fact that any financial turmoil could stop the Fed in its tracks," Jim Reid, Deutsche Bank's head of global credit strategy, said.

But FRC looks to have stabilized and is up 5% in Thursday premarket trading, while the iShares Regional Banks ETF ( IAT ) closed higher on Wednesday, indicating little fear of contagion.

The odds of a Fed pause have retreated to 25% and there is a near-90% chance priced in for a cut by the end of the year.

There still may be a reason for the Fed to take its foot off the brake next week, though, according to Steve Englander, macro strategist at Standard Chartered.

"The strategic reason to pause is that the FOMC’s emphasis on frontloading hikes generates expectations of a ‘hike, hike, pause, pause, cut, cut’ sequence of policy moves," Englander wrote. "In our view, it makes more sense to pause and indicate that a hike is likely to come."

"If the data come in as expected, the delay of six weeks in hiking will not be material," he said. "Moreover, if the upcoming data justify a June hike, the hike will likely be priced in well before the June meeting."

"Establishing the precedent that a pause does not mean a stop would signal to the market that a subsequent pause is similarly not a prelude to a stop or cut. The market may be skeptical that a June hike will follow a May pause, but the skepticism would last six weeks and provide the benefit of allowing FOMC actions to match new data."

"Knowing that the Fed could resume hiking after a pause would make investors less sure that a series of sequential hikes would be followed by sequential cuts," Englander added.

SocGen FX strategist Kit Juckes was more confident of a Fed pause but more skeptical that Fed chief Jay Powell and team could shift back into tightening mode.

"The shockwaves from the US regional bank crisis may be getting smaller, but they’re big enough to ensure a pause at next week’s FOMC meeting," Juckes wrote. "Surely the Fed will lean against pricing of Q4 rate cuts, but they can’t pause and simultaneously indicate they’ll have their hiking boots back on before the summer, can they?"

Tighter financial conditions as equity prices fall could give the Fed more reason not to hike. Despite the strong Big Tech earnings, the Nasdaq 100 ( NDX ) ( NASDAQ: QQQ ) is down 2.1% for the week and 3.5% for April. The S&P 500 ( SP500 ) ( SPY ) ( IVV ) ( VOO ) is off 1.9% for the week and 1.3% for the month.

"Big Tech’s index concentration is not new, dramatic, nor unprecedented," strategist Ben Laidler wrote. "Five largest S&P 500 stocks (AAPL, MSFT, AMZN, GOOG, NVDA) totaled over 20% of the index since 2019 vs. a chunky 50-year average concentration of 15%. In the 1970s ‘nifty fifty’ growth stock era it hit 25%. The relative performance gap is also still small."

More on the Fed

• Will Stress At The Banks Upend The Fed's Balancing Act?
• Federal Reserve Watch: Returning To Plan
• The Fed Is Set For A Massive Showdown With The Market

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