The Fed decision: hike is priced in, guidance matters more
The main market focus is the Fed. A 25 basis point hike is largely baked in, with the market pricing about a 90% chance of a hike. What the Fed projects going forward will drive the narrative, especially for longer-term rates.
There is a small chance of a hold. Giving a small weight to a hold is reasonable. If the Fed holds today, longer-term yields would likely rise a lot, and Fed credibility would come into question, since inflation has not moved down toward the 2% target. If the Fed hikes 25 basis points as expected, the yield curve would flatten: short-term rates higher, longer-term rates about unchanged or slightly higher.
This morning's data - resilient consumer spending and hotter inflation shown in import prices - gives monetary policy hawks some support for the afternoon decision.
The chief economist at BNY Investments expects a "one and done" this afternoon from the Fed chair.
Forward guidance and the language to watch
The Fed chair has been hawkish and tight-lipped, and has not moved yet. There was criticism of that silence, so more forward guidance or fuller answers may come in the press conference.
10-year Treasury yields break into three parts: inflation expectations, the term premium, and Fed funds expectations. Fed funds expectations have been the biggest driver of the recent rise in 10-year yields, because the market started pricing in more than one rate hike this year.
Any signal that the path is "one and one" or "two and one" could cap how much higher yields go from here.
The 5% yield level and equity technicals
The 5% level on the 10-year yield is key because it is the 2023 high. If yields do not push through 5%, the read could be that buyers step in there, lowering the odds of the next 10, 20, or 30 basis points of upside.
Markets sit at a critical point technically. The S&P 500 is at 7,600, a level tested many times over the past couple of months. If 7,600 does not hold, the next key level is about 7,300. The Russell 2000 is at a three-month low; 2,900 was a key level and it has broken below it. Small caps were the best performers a couple of months ago and are now the worst. The Nasdaq composite sits right at its 50-day simple moving average. Tension is building into the decision.
A relief rally is possible after getting the first rate hike in several years, given the buildup into it. But bond yields and bond volatility after the chair's comments will decide the reaction.
AI buildout as the tail risk
Oil and yields have both moved over the past six weeks in ways that surprise, yet there is still a bid under the market. That bid comes from earnings-per-share growth expectations, which are tied to the path of the AI infrastructure buildout.
The tail risk on the AI story has grown. Questions have come up around "not in my backyard" resistance to AI infrastructure and fears of rogue AI agents. Heading into the midterms, expect more commentary from politicians on where they stand on data centers. For now, the market gives the global economy and the AI buildout the benefit of the doubt.
Markets have shrugged off higher rates and yields because earnings estimates keep getting revised higher. If talk of an AI slowdown starts to hit capex and company guidance, that could threaten earnings estimates. That has not happened yet.
