Powell’s Battle-Ready Fed Puts Trump Trade to the Test

Jerome Powell's speech following the Federal Open Market Committee (FOMC) meeting emphasized the updated inflation outlook and the Federal Reserve's expectations for interest rate cuts in 2025, which received near-unanimous support from officials.

A month ago, Donald Trump's strategy for the US economy captured the attention of market participants, who believed it would lead to growth in the upcoming years.

As the holiday season approaches, Powell's assertive stance has once again taken center stage. His recent hawkish comments put inflation back in focus, leading to significant market fluctuations reminiscent of the volatility seen just after Election Day.

On Wednesday, Powell expressed reduced enthusiasm for further interest rate cuts, prompting a market sell-off that resulted in the worst performance for stocks and bonds in several months. However, sentiment shifted positively by Friday when the Fed’s preferred inflation measure revealed prices rising less than expected, leading to a rally that curtailed the S&P 500’s weekly losses.

The dramatic market shifts are fueled by strong convictions among investors, many of whom believe the Trump trade has more room to grow in riskier assets. Allocations to US equities reached an all-time high, while cash reserves diminished significantly, according to Bank of America's global fund manager survey. Even systematic investment strategies, like those focused on volatility control, have been seen increasing their stock market exposure.

The sharp market movements underscore how Trump influenced investor sentiment, but both the direction of inflation and Powell's response are critical considerations as valuations reach extreme levels. Despite Friday's rebound, the benchmark US equity index dropped around 2% over the week, with traditionally strong sectors like small caps and value stocks enduring their third consecutive week of decline.

“Investors found themselves believing that the Fed would lower rates regardless of the situation,” remarked Sameer Samana, a senior global market strategist at Wells Fargo Investment Institute. “The letdown came when the Fed recognized that inflation had not been decreasing as anticipated.”

Currently, the last remnants of the Trump trade manifest in rising bond yields, with rates on 10-year US Treasuries reaching their highest level in seven months. This shift stemmed from shrinking expectations for interest rate cuts following Powell's remarks, where he acknowledged that inflation remains persistent.

On Wednesday, when Powell's moderately hawkish statements led to significant market declines, the S&P 500 experienced one of its worst falls on a scheduled Fed meeting day since 2001. Powell insisted that the central bank would require more progress on inflation before considering further cuts.

As the US Fed and the Trump trade continue to influence the Dollar, recent moves highlight the volatility traders face. Signs of exhaustion were apparent even in highly active markets. For instance, Bitcoin—often seen as a symbol of Trump’s economic enthusiasm—fell below $100,000, resulting in a 10% drop for Michael Saylor's MicroStrategy Inc. A closed-end fund tracking private-company stakes, Destiny Tech100 Inc., also fell by around 15%, while the ARK Innovation ETF experienced its largest outflow in a month after the Fed meeting.

“Even those who anticipated a hawkish outcome during the Fed meeting were still caught off guard,” stated Max Gokhman, senior vice president at Franklin Templeton Investment Solutions. “This tug of war continues between those optimistic about unleashing investment through the new president's plans and those concerned that unchecked inflation will actually depress stock prices.”

In summary, investors who were initially excited about Trump's tax cuts and deregulation must now weigh this enthusiasm against the pressing reality of persistent inflation, largely influenced by Powell's stance. While Powell has refrained from directly linking the newly elected president's agenda to the Fed's tougher inflation approach, he has not entirely dismissed the implications either.

Volatility in Markets

The uncertainty regarding which factors to prioritize has led to significant cross-asset volatility. The VIX, commonly known as Wall Street's “fear gauge,” surged above 28 on Wednesday, a level not recorded since August, only to decline back under 20 by Friday. Meanwhile, 10-year Treasury yields increased significantly for nine consecutive days until Thursday, finally easing when the core personal consumption expenditures index reported its slowest monthly growth since May.

Over the past two weeks, US 10-year yields have jumped by approximately 37 basis points— marking the biggest rise in such a timeframe this year—with exchange-traded funds for both investment-grade and high-yield bonds experiencing declines. Bitcoin also suffered, with two of its worst trading days of the quarter occurring on Thursday and Friday, although it still remains over 100% higher compared to this time last year.

Not everyone has been adversely affected by these market fluctuations. Alessio de Longis, head of investments at Invesco Solutions, noted that he had positions since July that would benefit if stocks underperformed compared to bonds or defensive equities. While challenging during the euphoric phase under Trump, he remarked, “We are starting to see that unwind already. The election trades are beginning to lose steam.”

Powell, Trump, Inflation