What’s driving markets

Investor sentiment continues to be dominated by expectations of Federal Reserve monetary policy.

A 300 point gain for the Dow Jones Industrial Average was wiped out and then some on Monday after two Fed officials, San Francisco Fed President Mary Daly and Atlanta Fed President Raphael Bostic, said they thought the central bank will need to raise interest rates above 5%.

The comments meant the Fed was yet again looking to push back against market expectations that it would start trimming borrowing costs later this year, which were bolstered by a labor report last week that showed wage inflation slowing.

“The euphoria around Friday’s jobs data faded on Monday, when Fed officials came up and said that the Fed rates will go above the 5% level and stay there for some time,” wrote Ipek Ozkardeskaya, senior analyst at Swissquote Bank in a morning bulletin.

“Sounds familiar? Yes, it does, because the Fed officials have been saying that they will push the rates above 5% and keep them there for a long time to make sure that inflation is on a solid path toward the 2% target,” she added.

That switch from away from riskier assets is continuing in early Tuesday action, with traders warily eyeing a speech by Fed Chair Jerome Powell in Sweden, due at 9 a.m. Eastern, and then the consumer price index report on Thursday and the start of the fourth quarter company earnings season on Friday.

Jim Reid, strategist at Deutsche Bank, noted that Powell’s subject was central bank independence and thus it was “uncertain whether the topic in question will lead to an in-depth policy discussion.”

“But if we do get any, a key question will be whether he entertains the prospect of a further downshift in the pace of rate hikes to 25bps. That’s currently the base case in markets, but clearly the CPI release on Thursday will be an influence on this and to future FOMC meetings too,” Reid added.

Otherwise, it’s a thin day for economic data, with wholesale inventories at 10 a.m. Eastern.

Mark Newton, head of technical strategy at Fundstrat, said that the market’s reversal on Monday indicated the latest rally would fail and stocks this week would start heading back to the December 2022 lows.

“While Monday’s technology strength was seen as a positive for one-day performance out of this sector, Treasury yields and the U.S. dollar are right near support, and likely start to turn back higher over the next couple weeks. Overall, key areas to focus on lie near 3950-70 for SPX as resistance, and 3794-3800 as support…Any violation of 3794 should bring about a pullback to test and fractionally break 3700 before lows are in place for January,” Newton concluded