Wall Street Close: Stocks pull back following record high open as FOMC rate decision looms

• The S&P 500 pulled back from a record high open but still closed in the green.
• It was a broadly subdued day for equity markets, with investors keeping their powder dry ahead of Wednesday’s FOMC meeting.

It was a pretty quiet day on Wall Street. The S&P 500 slipped back from all-time high opening levels (as did the other major indices) but still managed to close higher by about 0.1% (another all-time closing high). The Dow dropped 0.3% while the Nasdaq gained half a percent. Small-cap stocks were the worst performers, with the Russell 2000 dropping 1.7%. The CBOE Volatility Index (or VIX) dropped to 19.79 (down 0.24 on the day) and looks on the verge of breaking lower towards pre-pandemic levels in the low teens.

In terms of the GICS sector performance, Energy fared the worst, dropping 2.8% on the session. Industrials and Financials were the next worst performers, dropping 1.4% and 1.1% respectively. Information Technology and Consumer Discretionary were the best performers, gaining 0.8% and 0.9% each.

Driving the day

As noted, it was a very subdued day on Wall Street, with stocks seemingly not showing too much concern amid weaker than expected US Retail Sales and Industrial Production data, both for the month of February. Weakness in the former is not expected to last long given US consumers are currently in the process of receiving another round of stimulus cheques, this one worth $1400, which ought to give retail spending a solid boost in March. Weakness in the latter is a little more concerning and could be reflective of some of the supply chain constraints being flagged in recent months in global PMI and ISM surveys – this could be a bit of a drag on the US economy over the coming months.

A decent 20-year US government bond auction eased concerns about the market’s ability to absorb US government debt issuance with the Fed buying bonds at its current pace, which out to come as a relief to the FOMC, who started their two-day meeting on Tuesday.

Otherwise, there was not much other news or fundamental catalysts for equity investors to get their teeth into. Focus is firmly on Wednesday’s Fed event…

Fed Preview

Meanwhile, Wednesday sees the FOMC release the result of their latest monetary policy decision; the bank is expected to hold interest rates at their zero-lower band (0.0-0.25%) and the rate of asset purchases steady at $120B per month (of which $80B are US government bonds).

The Fed statement and Fed Chair Jerome Powell’s remarks in the press conference are likely to stick to the usual dovish tone; i.e. no rate hikes until the bank has met its updated dual mandate (i.e. full employment and inflation that is moderately and sustainably above 2.0%), something which the Fed is likely to reiterate is still a long way off, and no tapering of asset purchases until substantial further progress has been made towards its dual mandate (something which Powell is also likely to say is a long way off).

The Fed will be releasing new economic projections which will be more closely scrutinised than usual; officials have been talking about how they expect inflation to pick up in the short-run and the updated inflation forecasts will formalise such expectations. The updated dot-plot is also of note; markets have brought forward their expectations of the first Fed hike as soon as late-2022/early-2023, despite the Fed’s old dot plot not forecasting any hikes through to 2024. Maybe the new dot plot might foresee a hike in 2023 (if not, that would be dovish).

Meanwhile, traders will also be on the lookout for any more information of if, when, and how the Fed might respond to further increases in US government bond yields, as well as any hints as to the conditions the Fed might want to see before tapering asset purchases – more information on the former is more likely than on the latter, as the Fed will likely want to avoid causing yields to move higher.

A few technical factors are also worth considering; bank SLF relief (which means they do not have to hold capital reserves for their treasury holdings) is set to expire this month and the Fed needs to decide whether to extend this. If not, this could cause some market problems as banks rush to meet their new, higher capital requirements. Some desks also think the bank might tweak the Interest of Excess Reserves Rate (IOER), which is a tool the bank uses to keep the Federal Funds rate within its target band – if they do, they will insist that this does not constitute a tweak to monetary policy, rather just a technical adjustment to maintain policy.