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The Fed meets next week. What can investors expect? Analysis by Krystal Hur, CNN Published 7:36 AM EDT, Sun June 11, 2023

Jun,11,2023 << Return list

     Stocks have just come off a seemingly auspicious week — but could the Federal Reserve’s June meeting dampen the rally?

The S&P 500 Index last week entered a bull market, meaning that it notched a 20% rally from its low in October. The Nasdaq Composite saw its longest streak of weekly gains since November 2019, powered by mega-cap tech stocks that have led the market higher in 2023.

Moreover, investors appeared calmer than they have in years, after the United States suspended the debt ceiling in time to avoid a default, allowing investors to breathe a sigh of relief. The Cboe Volatility Index, or VIX, last Thursday closed at its lowest level since January 2020. CNN’s Fear and Greed Index reached “extreme greed” on Thursday.

The stock market’s next test will be the Fed’s meeting on June 13 and June 14. Markets see a roughly 71% probability of a pause, according to the CME FedWatch Tool as of Friday afternoon.

The May Consumer Price Index and Producer Price Index reports, two key inflation prints, are also due the days that the Fed meets. While these readings, particularly the CPI, are generally seen as key indicators for how the data-dependent central bank will shape its monetary policy, investors are less concerned about how they will impact the Fed’s rate decision this time around.

“Unless that number is wildly away from expectations, I don’t think the Fed changes their minds on anything,” said JJ Kinahan, chief executive of IG North America.

That’s because Fed officials have indicated that they are likely to skip a hike in June. That’s different from a pause, since it suggests that the central bank could raise rates as soon as July after taking a break this month. Futures traders see a 53% chance of a July hike, though there’s also a roughly 31% chance of a pause that month, as of Friday afternoon.

Because the Fed has made its intentions clear, the rate decision itself is unlikely to move markets, says Karim El Nokali, investment strategist at Schroders. He adds that there are still some factors that could help drive stocks higher next week, such as cool inflation prints or more dovish commentary from Fed Chair Jerome Powell at the post-meeting press conference.

But that also means Fed talk that hints at further tightening could dampen the market’s rally.

“If the market took it as it is particularly hawkish, that would definitely be an excuse to see a bit of a sell-off here,” El Nokali said.

Moreover, markets on June 16 are due for a “quadruple witching,” which is when options and futures on indexes and stocks expire simultaneously.

That could inject some volatility into the market near the end of the week, said Kinahan.

Why is there no alternative safe asset to Treasuries?

While the United States earlier this month avoided breaching the debt ceiling, its close brush with potential economic and financial catastrophe — along with the possibility of a credit downgrade — has resurfaced a perennial question: Is there a viable alternative to the quintessential safe asset, US Treasuries?

The short answer, according to most investors, is no.

President Joe Biden on June 3 finally signed into law a bill suspending the United States’ $31.4 trillion debt limit through January 1, 2025, putting to bed weeks of concerns that the nation could default on its debt.

But the United States could still suffer a downgrade to its credit rating, even though it avoided losing its ability to make payments on time. Fitch Ratings warned earlier this month that it is keeping the country on watch for a potential downgrade by the end of September.

It’s unlikely, however, that the loss of the coveted AAA rating from Fitch would impact Treasuries’ status as the safe asset’s poster child. In fact, Treasuries are so irreplaceable as a haven that a credit downgrade could actually spark a rally, said Benjamin Jeffery, vice president of rates strategy at BMO Capital Markets.

While seemingly counterintuitive, that’s what happened in 2011, when the United States nearly defaulted on its debt and Standard & Poor’s downgraded America’s credit rating.

That’s because investors are conditioned to seek safety during times of market turbulence. Treasuries are perceived globally as one of the world’s most risk-free, if not the most risk-free, assets — and the United States nearly defaulting on debt has done little to change that.

In other words, “any credit rating movement would be more of an embarrassment to the US than an impact to investors,” said Patrick Klein, portfolio manager at Franklin Templeton Fixed Income.

Several reasons underscore Treasuries’ pristine reputation, including that no other country has a currency market that is as liquid, large or highly rated as that of the United States.

“The US government issues something the rest of the world desperately wishes it had,” Josh Lipsky, senior director of the Atlantic Council’s GeoEconomics Center and former adviser at the International Monetary Fund, wrote in May.

The US government has roughly $31.9 trillion of total public debt outstanding, according to data as of June 8 from the Treasury Department.

While the US government has come close to defaulting on its debt before, it’s never actually happened. Moreover, the government is seen as a far more stable entity than a corporation, for instance, since it can impose taxes and take other measures to ensure it doesn’t run out of cash. That makes it an ideal issuer of debt.

Other safe assets exist but pale in comparison to Treasuries. Gold, for example, is a haven prized for its price stability even when the rest of the market experiences volatility.

But the precious metal’s prices are beholden to factors that government debt is not, including a supply that is controlled by miners. That makes the market too risky to underpin a financial system in the same way as the US Treasury market, said Olivier d’Assier, head of APAC applied research at Qontigo.

Moreover, Treasuries are denominated by the US dollar, the world’s leading reserve currency — a position unlikely to be supplanted by another form of exchange such as gold, despite the value that it holds.

“It’s not like we all carry around a bunch of gold bars in our pockets to use at the grocery store,” said George Mateyo, chief investment officer at Key Private Bank.

Up Next

Monday: Federal Reserve Bank of New York Survey of Consumer Expectations.

Tuesday: Consumer Price Index report for May and NFIB small business optimism index. Federal Reserve begins its two-day meeting.

Wednesday: Producer Price Index report for May. Federal Reserve interest rate decision and post-meeting press conference.

Thursday: Retail sales for May, mortgage rates and weekly jobless claims.

Friday: University of Michigan preliminary reading of consumer sentiment in June.

Source:CNN