The Federal Reserve isn’t trying to hit the stock market as it quickly raises interest rates in an attempt to slow still-simmering inflation — but investors should brace for more pain and volatility because policymakers won’t be spooked by deepening the selloff, investors and strategists said.
“I don’t think they’re necessarily trying to reduce inflation by destroying stock or bond prices, but it’s having that effect,” Tim Courtney, chief investment officer at Exencial Wealth Advisors, said in an interview.
US stocks fell sharply in the past week after hopes of a marked cooling in inflation were scorched by hotter than expected August inflation reading. The data bolstered expectations among federal funds futures traders for a rate hike of at least 75 basis points when the Fed concludes its policy meeting on Sept. 21, with some traders and analysts expecting a hike of 100 basis points or a full percentage point.
The Dow Jones Industrial Average
posted a 4.1% weekly decline, while the S&P 500
fell 4.8%, and the Nasdaq Composite
suffered a decline of 5.5%. The S&P 500 ended Friday below the 3,900 level, seen as an important technical support area, with some chart watchers eyeing the potential for a test of the large-cap benchmark’s 2022 low at 3,666.77, set on the 16 June.
A profit warning from global shipping giant and economic leader FedEx Corp.
further fueling recession fears, contributing to Friday’s stock market losses.
Treasuries also edged lower with yields on 2-year Treasuries
jumped to a near 15-year high above 3.85% on expectations that the Fed will continue to raise rates in the coming months. Yields rise as prices fall.
Investors are operating in an environment where the central bank’s need to rein in stubborn inflation is widely seen eliminates the idea of a figurative “Fed put” on the stock exchange.
The concept of a Fed put has been around since at least the October 1987 stock market crash that prompted the Alan Greenspan-led central bank to cut interest rates. An actual put option is a financial derivative that gives the holder the right, but not the obligation, to sell the underlying asset at a specified level known as the strike price, serving as an insurance policy against a market downturn.
Some economists and analysts even suggest the Fed should welcome or even seek market losses, which could serve to tighten financial conditions as investors cut spending.
William Dudley, the former president of the New York Federal Reserve, argued earlier this year that the central bank would not deal with inflation it’s near a 40-year high unless they make investors suffer. “It’s hard to know how much the Federal Reserve will need to do to rein in inflation,” Dudley wrote in a Bloomberg column in April. “But one thing is certain: to be effective, it will have to inflict more losses on stock and bond investors than it has so far.”
Some market participants are not convinced. Aoifine Devitt, Chief Investment Officer at Moneta, said the Fed likely sees stock market volatility as a byproduct of its efforts to tighten monetary policy rather than a goal.
“They recognize that stocks can be collateral damage in a tightening cycle,” but that doesn’t mean stocks “need to crash,” Devitt said.
But the Federal Reserve is willing to tolerate falling markets and slowing the economy and even falling into recession as it focuses on taming inflation, she said.
The Federal Reserve kept the fed funds rate target in a range of 0% to 0.25% between 2008 and 2015 as it dealt with the financial crisis and its aftermath. The Fed also cut interest rates to near zero again in March 2020 in response to the COVID-19 pandemic. With interest rates low, the Dow
skyrocketed more than 40%, while the large-cap S&P 500 index
jumped more than 60% between March 2020 and December 2021, according to Dow Jones market data.
Investors got used to “the tailwind of more than a decade of falling interest rates” while waiting for the Fed to step in with its “put” if things got volatile, said Courtney of Exencial Wealth Advisors.
“I think (now) the Fed’s message is ‘you’re not going to get that tailwind anymore,'” Courtney told MarketWatch on Thursday. “I think the markets can grow, but they will have to grow on their own, because the markets are like a greenhouse where the temperatures have to be kept at a certain level all day and all night, and I think that’s the message that the markets can and they should grow on their own without the greenhouse effect.
Meanwhile, the Fed’s aggressive stance means investors should be prepared for what could be “a few more daily downward strokes” that could ultimately turn out to be “one last big flush,” said Liz Young, head of investment strategy at SoFi, on Thursday Note.
“This may sound strange, but if it happens quickly, meaning within the next few months, it actually becomes a bull case in my opinion,” she said. “This could be a quick and painful downturn, leading to a renewed uptick later in the year that is more durable as inflation falls more markedly.”