A hawkish Fed, shaky tech and the risk of an earnings letdown

Markets are now heading into the last two months of the year, having closed out October with a flurry of significant events.

First off, the US Federal Reserve, European Central Bank, and Bank of Japan all held monetary policy meetings in the final week of October, and interest rates were left unchanged, as expected.

That removes a potential short-term headwind for equities.

Yet there’s still a general expectation that central banks will tighten monetary policy before the year-end, due to stubbornly high inflation.

Focusing on the US, the CME’s FedWatch Tool puts the probability of a 25-basis-point rate hike in early December at around 70%.

And if it once again chooses to leave rates on hold through to the year-end, then there’s less than a 10% chance that it won’t have hiked by mid-March 2027.

The interesting thing is that markets were more hawkish before the Fed meeting than after.

This is despite two FOMC members voting for an increase on Wednesday. Some observers considered that choice to be performative.

That could be the case, knowing that the majority wanted to hold, and given the problems that another hike would cause coming just a few days before the dreaded midterms – more in a minute.

But when it comes to pricing pressures, who can blame them? The major inflation updates released earlier this month were horrible.

September Core and Headline CPI both came in way above expectations and the prior month’s readings, with Headline being the highest number year-on-year since May.

Following this, the PPI data (the key measure of wholesale inflation, which typically leads consumer prices) proved to be even more shocking, with Core and Headline hitting highs last seen nearly four years ago.

To top it all, the day after the Fed left rates on hold, Core PCE, still the Fed’s preferred inflation measure and the one used for its 2% target, ticked up to 3.1% from 3.0%.

Not only is it moving in the wrong direction, but the last time it was below the Fed’s target rate was in February 2021.

Perhaps the Fed is hoping that a new virus will come and do its job for it again.

Failing that, if the tech sector selloff accelerates from here, the Fed could soon be cutting rather than hiking.

Bear in mind, the Fed, under its newish Chair Kevin Warsh, has made it clear that it will now be led by the data, rather than guiding the markets to a preordained route for monetary policy.

It has also said that getting inflation back down to its 2% target remains its number one priority.

Yet there was a dismal Non-Farm Payroll update in early October, along with an unwelcome uptick in the Unemployment Rate.

And it’s not the first time that payrolls have disappointed since the summer.

This has led some observers to wonder about the underlying health of the US economy once growth from the AI infrastructure buildout is subtracted.

That’s not to say that the AI trade isn’t genuine, only that it is highly concentrated and in danger of unravelling if certain optimistic assumptions don’t play out as currently priced.

And that brings us to the third quarter earnings season.

Earnings growth has been the biggest tailwind for US equity markets for years now.

And it is expected to continue into this quarter as well, with a year-on-year earnings growth rate forecast around 30%.

That could well come to pass. But results from Meta Platforms, Alphabet and Amazon have really put the skids under the hyperscaler trade.

Meanwhile, and ahead of the upcoming Anthropic IPO, the only listed frontier lab, SpaceX, is trading at its lowest level in two months.

The chip sector looks like a bloodbath, and neoclouds aren’t looking particularly perky either.

Who knows how this will play out. Another ‘buy the dip’ opportunity?

Investors are now preparing for the midterm elections on the 3rd of November.

History shows that what happens after midterm elections has little overall effect on US stock market performance.

Corporate earnings, economic growth, employment, inflation and interest rates tend to matter far more.

Despite this, there have been times when politically sensitive sectors such as energy, healthcare and tech have faced different degrees of scrutiny following a change in control of Congress.

That can lead to a period of sector rotation, rather than the whole market moving one way.

Aside from this, a look at past midterms shows that political gridlock is a common outcome, and that often goes down well with financial markets.

The president’s party usually loses seats, and a split government is often seen as placing a limit on what an administration can do.

That could be considered a significant issue in the current political environment.

The polls close on the 3rd of November, and prediction markets suggest that a Republican-controlled Senate and a Democrat-controlled House are the most likely outcome.

This will be both an annoyance and a constraint for President Trump.

But it won’t affect his ability to issue executive orders, as well as deciding much of trade and foreign policy, including going to war.

So, as October draws to a close, the biggest challenge remains beating lofty earnings expectations. What could possibly go wrong?

(This is a fortnightly column by David Morrison. He is a Senior Market Analyst at Trade Nation. Views are his own.)