Traders don't want to believe the Fed, so get used to a lot of choppiness

Is this what the first half of 2023 is going to look like? Markets rally. Then Fed officials get on the tape say they’re going to keep raising rates and keep them high until hell freezes over. Markets drop. I’m not kidding. Atlanta Fed President Raphael Bostic on Monday said the central bank should raise interest rates above 5% and stay there for “a long time.” Markets drop. Is this what the first half of 2023 is going to look like? Inflation data continues to show signs of cooling, but it’s still high, and the Fed doesn’t want to declare victory so they keep jawboning the markets down. The source of tension is that the trading community doesn’t want to believe the Fed, and many are arguing the Fed is using stale data. “Wall Street does not believe the story being spun by the Fed,” Harry Katica from Saut Strategy told his clients. “According to traders, the economy is slowing quickly,” Katica says. “It will take up to a month for the data to be released publicly. Traders are not waiting for evidence. They have been piling into the 2-Year Treasury note futures, which have rallied the last two trading sessions. …Traders are betting interest rates are going down due to a weak economy. The higher the Fed takes short term rates, the deeper and longer the slowdown will be, they say. Markets think the Fed is making a big mistake.” And all this bluster that the Fed will raise rates past 5%? Many on the Street don’t believe that either. Krishna Guha, vice chairman and head of the Global Policy and Central Bank Strategy team at Evercore ISI, expects the Fed to slow the pace of hikes in February and to stop at a fed funds rate of 4.75 to 5%, for example. Even JP Morgan’s Marko Kolanovic thinks that a soft landing is the likely current scenario: “The latest news [on jobs and wage inflation] modestly alters our perception of risk and the probability we place on a global recession in 1H23 falls to 15% (from 20%),” the chief market strategist wrote in a note to clients Monday afternoon. “With inflation now falling faster than we expected and with U.S. wage inflation also moderating, soft-landing scenarios should not be ignored.” With all this confusion, it is a little comforting to see some “early warning” trading patterns come out positive. The First Five Days indicator is up. It’s considered an “early warning system”. The last 46 times the first five days of the year were up were followed by full-year gains 38 times (82.6% accuracy) and a 13.7% gain in all 46 years, according to the folks at the Stock Trader’s Almanac. That makes it two in a row for the early indicators. Jeff Hirsch at the Stock Trader’s Almanac noted that both the Santa Claus rally (last 5 days of the old year, first 2 of the new year) and the First Five Days indicator have been positive. Now all we need is the January Barometer: the month of January predicts the year’s course with a .732 batting in 71 years. That would be a trifecta.