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Dow Teeters on Knife Edge Because the Fed May Kill the Money Cannons

Last Updated September 23, 2020 1:59 PM
Ben Brown
Last Updated September 23, 2020 1:59 PM
  • The Dow Jones teetered on Wednesday, although the Nasdaq raced toward a second straight all-time high.
  • All eyes are on Federal Reserve chairman Jerome Powell as he prepares a 2:30 pm ET policy speech.
  • Investors are pricing more dovish commitments from the Fed, but what if they start rolling back instead? Risk assets could sell off.

Traders slammed the brakes yesterday to snap a six-day Dow Jones Industrial Average (DJIA) winning streak, and the stock market’s bellwether index continued to teeter on the knife edge on Wednesday.

All eyes are on the Federal Reserve policy statement  this afternoon. Investors fully expect chairman Jerome Powell to keep the money cannons firing. But, what if he shocks the market and backs off?

According to strategist Patrik Schowitz at JPMorgan, it’s one of their biggest concerns right now:

One of the near-term risks to the market is that we can get a mini taper-tantrum where the Fed rolls back… That certainly wouldn’t be appreciated by equities or risk assets in general.

If Powell came out and surprised everyone today with a hawkish tone, there’s no doubt we see a sell-off in stocks.

The Dow is paralyzed ahead of Powell’s statement

After a volatile overnight session, the Dow Jones opened flat on Wednesday morning. As of 9:31 am ET, the DJIA had lost 27.63 points or 0.1% to trade at 27,244.67.

The tepid move comes after a delirious six-day winning streak that saw stocks extend into near-euphoric territory.

dow jones industrial average, djia today
The Dow is trading flat ahead of Jerome Powell’s statement today. | Source: Yahoo Finance

The S&P 500 crept toward minor gains, rising 0.27% to 3,215.71.

But tech investors appear to have thrown caution to the wind. The Nasdaq continues to act as the market’s safe haven, rising 69.17 points or 0.69% to 10,022.93.

This comes after the index hit another all-time high yesterday, briefly surpassing the 10,000 mark for the first time ever.

What if the Fed starts rolling back?

The Federal Reserve pulled out its biggest monetary bazooka during this crisis. Powell slashed rates to near-zero and promised an endless flow of liquidity to the financial markets. The Fed balance sheet has since ballooned to more than $7 trillion .

The unprecedented response worked. So should the Fed start easing off? Consider the recent developments:

  • Employment numbers bounced back much stronger than expected.
  • The worst of the economic damage appears to be over. The recovery has begun.
  • The stock market has fully recovered. The S&P 500 is now close to record highs.

The Federal Reserve might consider it ‘job done’ and start to taper off its asset purchases. Indeed, Powell has previously hinted that the Fed has done its part and Congress needs to take the baton from here  with more fiscal stimulus.

Powell might also consider the implications of helping pushing the stock market to record highs amidst a national crisis.

It has happened before. Remember the 2018 stock market correction?

When the Fed began slowly tightening monetary policy back in late 2018, the stock market shuddered hard . On December 19th, the Dow collapsed 350 points as Powell hiked the base rate and announced the Fed would shrink its balance sheet.

Dow Jones crash 2018
The stock market collapsed down to its yearly low at the end of 2018 as the Fed began tightening policy. Source: TradingView

The stock market hit a one-year low in the days that followed. In other words, investors do not want to see the Federal Reserve back off.

Any hawkish tone could trigger a Dow Jones selloff

Analysts aren’t expecting any big policy shifts in today’s statement. And, at these levels, the stock market is almost certainly pricing in a continuation of the Fed’s policy. And while Schowitz has one eye on the Fed backing off, he doesn’t actually think it will happen:

I think it would be quite dangerous for them to get into that game already… It’s too early to go there.

Still, it’s something investors should bear in mind. Powell’s statement at 2:30 pm ET today will wrap up a two-day meeting. In addition to the policy statement, Powell will give the central bank’s overview of the economy at large.