Wednesday’s Fed Announcement Amid Russian Instability

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On Friday, we were surprised to see Deutsche Bank reverse course and announce they will cease doing business in Russia as part of a corporate banking pressure campaign to end the war on Ukraine. If even Deutsche Bank is unwilling to deal with the Russian government, then sanctions have gotten very extreme.

A photo of the outside of the Federal Reserve Building.

Source: Shutterstock.com

We don’t know yet how bad the economic picture in Russia is getting. The Russian stock market has been closed since February and will remain closed until at least March 18. The last reliable quotes on the ruble showed it had lost 40% against the dollar.

The effect of economic sanctions and the war on Ukraine are, of course, having a terrible effect on the people of both countries. Despite the terrible costs of the war and sanctions, it seems that the potential for a pathway back to normalcy could appear in the short term. We don’t want to get too far ahead of ourselves, but if traders expect to hear some good news this week, we should see the market rally.

However, the Fed will also be making news this week…

The Federal Reserve will make an announcement on Wednesday about interest-rate targets and the economy. When the bond market closed last week, traders were pricing in a 95% chance that the Fed would raise “rates” by .25%. The Fed rarely misses the bond market estimate on the week of an announcement, so we can assume a small hike will happen.

However, this can be a tricky topic because of the way it is usually reported in the press.

The Fed is not raising all interest rates; it is raising the overnight rate that banks charge each other for short-term loans. When that rate rises or falls, there is not always a proportional reaction in other interest rates. In other words, if the Fed raises the overnight rate by .25%, an auto loan or mortgage is not necessarily going to be more expensive.

Just like most factors in the market, interest rates are subject to the forces of supply and demand. So if demand remains high, long-term interest rates that affect mortgages, student loans, etc. would keep rising whether the Fed did anything with the overnight rate. In fact, that’s exactly what’s been happening since April 2020. The Fed hasn’t touched the overnight rate, but long-term rates have been rising with demand for loans.

So what’s the point?

Let’s assume that news from Ukraine is either positive or at least not worse than it has been last week. That should give traders some breathing room to focus on the Fed. However, sentiment is a tricky thing. Because most investors do not understand the relationship between the Fed and long-term interest rates, any surprises in the statement will likely create some volatility.

In other words, if the Fed hints that they are going to keep raising the overnight rate (and we think they will), then investors will probably sell on that news. Historically, that is pretty common.

What should you do?

The good news is that because the market has been stable at support over the past few weeks, any short-term selling on Wednesday should trigger bargain hunters to jump back into the market. Right now, we still feel strongly that the likely beneficiaries of that buying are going to be tech and retail stocks. Like most other sectors, tech and retail have been trapped under the bad news related to Ukraine and the associated inflationary pressures in the energy market. However, once traders have the Fed out of the way, conditions will be perfect for the bounce we have been looking for.

On the other hand, we also have to reiterate our warning for traders who jumped in late to the energy rally. We don’t think the gains over the past two months will completely evaporate, but we would expect 70-80% of the gains over the past 60 days will collapse with any progress in the Ukraine crisis.

Oil already lost 15% last week just on hints that other supplies would ramp up production. So, if oil drops back to $95 per barrel, we should see stock prices in the energy sector come down as well.

Bottom Line

Ukraine is still the dominant news issue; however, there continues to be signs that sanctions and corporate pressure are having an effect. Talks between Ukraine and Russia continued all weekend, and we expect this to prime investors to be in a buying mood after we get past the Fed’s rate hike on Wednesday. Tech and retail still look good, but energy is very risky.

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