Is the stock market about to hit a new low? What investors need to know when the Fed signals interest rates will be higher in the long run.
Federal Reserve Chairman Jerome Powell has sent a clear signal that interest rates will go higher and stay there longer than previously anticipated. Investors wondered if that meant fresh stock market lows were beaten still ahead.
“If we don’t see inflation start to fall as lending rates go up, we won’t get to the point where the market can see the light at the end of the tunnel and start to turn,” said Victoria Fernandez, chief market strategist School at Crossmark Global Investments said. “You usually don’t bottom out in a bear market until the funding rate is above the inflation rate.”
US stocks initially recover after Wednesday’s Federal Reserve Day passed a 75 basis point rally for the fourth time in a row, which put lending rates between 3.75% and 4%, with a statement that investors interpreted as a signal that the central bank will make smaller rate hikes in the future . However, the more aggressive Powell than expected poured cold water on the half-hour market party, sending stocks plummeting and Treasury yields and providing high futures funds. than.
See: What’s next for markets after the Fed’s 4th consecutive rate hike
In a press conference, Powell emphasized that it is too early to think about a pause in rate hikes and said that the final level of the federal funds rate is likely to be higher than what policymakers expect. in September.
Markets are currently pricing in a more than 66% chance of a rise of just half a percentage point at the Fed’s Dec. CME FedWatch Tool. That would put loan rates in the 4.25% to 4.5% range.
But the bigger question is how high the final rate will be. In the September forecast, Fed officials have an average of 4.6%, which would show a range of 4.5% to 4.75%, but economists are currently contributing to year-end rate is 5% by mid-2023.
Read: 5 things we learned from Jerome Powell’s ‘cloud whip’ press conference
The Fed also acknowledged for the first time that the cumulative tightening of monetary policy could eventually cause the economy to lag behind.
Strategists say it usually takes six to 18 months for a rate hike to pass. The central bank posted a first-quarter basis point increase in March, meaning the economy will start to feel some of the full effects of that later this year and won’t feel the effects. The maximum result of the fourth week is 75 basis points increased until August 2023.
“The Fed wants to see a bigger impact from the tightening through the third quarter of this year on financial conditions and the real economy, but I don’t think they are seeing a big enough impact,” said Sonia Meskin, head of . on US macro at BNY Mellon Investment Management. “But they also don’t want to accidentally kill the economy… that’s why I think they’re slowing it down.”
Mark Hulbert: This is strong new evidence that a rally in the US stock market is imminent
Mace McCain, chief investment officer at Frost Investment Advisors, said the main goal is to wait until the maximum impact of the rate hikes is carried over to the labor market, as higher interest rates drive home prices higher. , resulting in more inventories and less construction, boosting a less resilient labor market.
However, government data showed that on Friday, the US The economy posted an amazingly strong increase with 261,000 new jobs in October, beating the Dow Jones estimate of 205,000 additions. Perhaps more encouragingly for the Fed, the unemployment rate rose to 3.7% from 3.5%.
US stocks rallied in a volatile session on Friday as investors assess what the mixed jobs report means for future Fed rate hikes. But the major indexes posted weekly declines, with the S&P 500
SPX,
down 3.4%, the Dow Jones Industrial Average
DJIA,
down 1.4% and Nasdaq Composite
COMP,
decreased by 5.7%.
Some analysts and Fed watchers have argued that policymakers would prefer stocks are still weak as part of their efforts to further tighten financial conditions. Investors may wonder what destruction of wealth the Fed can accept to destroy demand and curb inflation.
“It remains open to debate because with the cushion of the stimulus components and the cushion of higher wages that many people have been able to earn over the past few years, the destruction of demand won’t happen as easily. it will happen. in the past,” Fernandez told MarketWatch on Thursday. “Obviously, they (the Fed) don’t want to see the stock market crash completely, but as in the press conference [Wednesday], that’s not what they’re looking at. I think they are okay with a little bit of wealth destroyed.”
Meskin of BNY Mellon Investment Management is concerned that there is only a small chance that the economy can achieve a successful “soft landing” – a term used by economists to refer to an economic downturn to avoid fall into recession.
“The closer the Fed gets to their own estimated neutral rate, the more they try to adjust for subsequent increases to gauge the impact of each hike as we move to,” Meskin said by phone. a restricted area. The neutral rate is the level at which the lending rate does not promote or slow down economic activity.
“This is why they said they would sooner rather than start raising rates by a smaller amount. But they also don’t want the market to react in a way that loosens financial conditions because any easing of financial conditions will cause inflation.”
Powell said on Wednesday that there was still a chance that the economy could come out of a recession, but that chance for soft landing has shrunk this year as price pressure has been slowly eased.
Still, Wall Street investors and strategists are still divided over whether the stock market is fully priced in a recession, especially with relatively strong third-quarter results. from more than 85% of S&P 500 companies that have reported and expected earnings.
“I still think if we look at earnings expectations and market prices, we’re not really pricing in a significant recession,” Meskin said. “Investors are still assigning a reasonably high probability of a soft landing,” but the risk that “very high inflation and higher Fed-estimated end-of-term rates is that we will eventually have to have much higher unemployment rates and therefore much lower valuations. ”
Sheraz Mian, director of research at Zacks Investment Research, said the margins are growing better than most investors expect. For the 429 S&P 500 members that reported results, total earnings rose 2.2% year over year, with 70.9% beating EPS estimates and 67.8% beating estimates. revenue, Mian wrote in one article on Friday.
And then there are midterm parliamentary elections on November 8.
Investors are debating whether stocks can rally after a close battle for control by Congress because historical precedent points to a tendency for stocks to rise after voters go to the polls.
See: What midterms mean for the stock market’s ‘best 6 months’ as favorable schedule is underway
Anthony Saglimbene, chief market strategist at Ameriprise Financial, said markets typically see stock volatility increase 20 to 25 days before an election, then drop lower 10 to 15 days after. when the results are available.
“We really saw that this year. When you look from mid and late August at where we are now, volatility has increased and it’s starting to get lower,” Saglimbene said on Thursday.
“I think one of the things that is allowing the market to push back the midterm elections is that the percentage of divided government is going up. In terms of market reaction, we really think the market might react more strongly to anything that falls outside of a divided government,” he said.
