Traders Pour Money Into ETFs as Federal Reserve Policy Sparks Debate
Traders are not hesitating to invest their money across various markets as they navigate the ongoing debate over Federal Reserve policy and how Jerome Powell should handle soaring asset prices. Over the past five months, more than $46 billion has been sent to exchange-traded funds (ETFs) tracking corporate bonds, marking the highest inflow since the Fed’s efforts to support the market during the Covid-19 pandemic. In total, ETFs tracking stocks, fixed income, and commodities have attracted a staggering $374 billion during this period, which is the most in two years.
Rallying Equities with No Precedent
The equity rally in recent times is unprecedented as the S&P 500 has surged 27% since October, on track for its largest-ever advance since at least 1970. This surge is occurring ahead of an anticipated monetary-easing cycle, according to data from Ned Davis Research and Bloomberg. The stock market just had its best week of the year following the Federal Reserve meeting and press conference, which added fuel to the already burning fire in markets since October.
Traders have sensed a change in tone from policymakers, with growing comfort regarding a slower path to achieving their 2% inflation goal. Powell repeatedly mentioned that this path will be “bumpy.” However, many consider it dubious at best when considering that $13 trillion has been added to stock and bond values since October alone. Traders believe that what matters most at these times is what is said rather than what should be said.
Traders Celebrate Fed’s Dovish Outlook
Powell’s refusal to mention markets or excessively worry about higher-than-expected consumer price data has solidified his reputation as investors’ ally-in-chief. He has shown a disinclination to take the bait to jawbone markets lower. The newly released Fed estimates indicate that policymakers remain committed to three rate reductions in 2024, even as their forecasts for inflation and growth increase. Bond traders have assigned a 69% probability for the first rate cut to happen in June.
Despite previous instances where both traders and the Fed overestimated the prospects for dovishness, this time may be different. However, with technology stocks in the S&P 500 trading near 30 times earnings estimates, even an anticipated easing cycle may not be sufficient to further boost returns. Nevertheless, the celebration in the market continues with no signs of slowing down.
Easing Volatility Across Assets
Volatility has been decreasing across various assets, particularly in Treasuries. Previous bouts of turmoil had hindered gains in stocks, cryptocurrencies, and credit. The ICE BofA MOVE Index, which tracks expected turbulence in US bonds via options on interest-rate swaps, is now at levels last seen before the central bank initiated its policy-tightening campaign in 2022.
During this week, equities, fixed income, and commodities all posted harmonized gains according to ETFs tracking their returns. Bitcoin experienced a slight retreat after reaching $73,000 for the first time but is still up by 50% since January. The Fed’s reiteration of its dovish outlook drew criticism from figures like former Treasury Secretary Lawrence Summers who questioned the urgency of rate cuts. However, with Powell signaling a willingness to let the economy run hot, bullish investors took it as a buy signal.
Fed Day Performance
The S&P 500 index rose almost 1% on Wednesday, marking the eighth-best performance on a Fed day during Powell’s tenure. This reaction was in contrast to January when Powell dampened hopes of rate reductions beginning in March. The buoyancy in the market also defied the trend since Powell took over as Fed chair in 2018, where the equity benchmark tended to slide after the afternoon’s press release.
Market experts are beginning to observe a potential shift in the market’s reaction to Powell’s Fed meetings. If rate hikes are off the table, investors may be more patient with the timeline of rate cuts.
Surprising Market Resilience
The market’s resilience has caught some analysts by surprise. Many had expected sell-offs following technology, media, and telecom events, along with concerns that the Fed would adopt a more hawkish stance due to rising inflation data. However, these expectations did not materialize. Investors withdrew $24 billion from US stock ETFs in the week leading up to the Fed meeting but added nearly $2 billion back in the following session.
Historical Performance and Future Outlook
Looking back at previous rate-cut cycles, it is evident that investors tend to benefit if the Fed’s rate scenario unfolds as expected. In all but one of the past 12 rate-cut cycles, stocks have risen, with the S&P 500 climbing a median of 15%. This favorable pattern also holds true for Treasuries and corporate bonds, although their performance can only be tracked back to a more recent period.
Some portfolio managers expressed disappointment that Powell did not make a stronger commitment to the central bank’s inflation target. They believe he needs to tread carefully in an election year, as any major policy shift could draw criticism from both Republicans and Democrats. The Fed is signaling that they may quietly abandon their immediate goal of 2% inflation and be willing to tolerate higher inflation. However, making significant changes to monetary policy during a contentious election could present troubling optics for the Fed.
Hot Take: Traders Remain Bullish as Fed Policy Sparks Debate
The ongoing debate over Federal Reserve policy and how Jerome Powell should handle soaring asset prices has not deterred traders from investing their money across various markets. Despite concerns about the Fed’s inflation target and the potential impact of rate cuts, traders remain optimistic and continue to pour money into ETFs. The market’s resilience and the Fed’s dovish outlook have solidified Powell’s reputation as investors’ ally-in-chief. However, only time will tell if this optimism will be sustained in the long run.
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