Federal Reserve Chairman Jerome Powell sent a clear signal that interest rates will rise and stay there longer than expected. Investors are wondering if this means new lows are ahead for the battered stock market.
“If we don’t see inflation start to come down while the federal funds rate goes up, then we’re not going to get to the point where the market can see the light at the end of the tunnel and start to make a turnaround,” said Victoria Fernandez, chief market strategist at Crossmark Global Investments. “You usually don’t bottom out in a bear market until the fed funds rate is higher than the inflation rate.”
US stocks initially rose after the Federal Reserve on Wednesday approved a fourth consecutive increase of 75 basis points, with the federal funds rate in a range between 3.75% and 4%, in a statement that investors interpreted as a signal that the central bank will provide smaller rate increases in the future. However, a more hawkish-than-expected Powell poured cold water on the half-hour market party, sending stocks sharply lower and Treasury yields and fund futures higher.
At a news conference, Powell stressed it was “very premature” to think about a pause in interest rate hikes and said the final level of the federal funds rate was likely to be higher than policymakers expected in September.
According to CME FedWatch tool. That would leave the federal funds rate in the 4.25% to 4.5% range.
But the bigger question is how high interest rates will ultimately be. In the September forecast, Fed officials had a median of 4.6%, which would have meant a range of 4.5% to 4.75%, but economists now write with a pencil a final rate of 5% by mid-2023.
For the first time, the Fed also acknowledged that cumulative monetary tightening could end up hurting the economy with a “lag.”
It usually takes six to 18 months for a rate hike to materialize, strategists said. The central bank announced its first quarterly basis point hike in March, meaning the economy should begin to feel some of the full effects of this by the end of this year and will not feel the full impact of this week’s fourth 75 basis point hike until August 2023
“The Fed would like to see a bigger impact from the tightening in the third quarter of this year on financial conditions and on the real economy, but I don’t think they see enough of an impact,” said Sonia Meskin, head of US macro at BNY Mellon Investment Management. “But they also don’t want to inadvertently kill the economy … which is why I think they’re slowing down.”
Mace McCain, chief investment officer at Frost Investment Advisors, said the main goal is to wait until the maximum effects of rising interest rates have passed through the labor market, as higher interest rates lead to higher prices for housing, followed by more inventory and less construction, fueling a less resilient labor market.
However, government data showed on Friday the US the economy gained a surprisingly strong 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 ended sharply higher in a volatile trading session on Friday as investors assessed what a mixed jobs report meant for future Fed rate hikes. But major indexes posted weekly declines, such as the S&P 500
down 3.4%, the Dow Jones Industrial Average
down 1.4% and the Nasdaq Composite
there was a decline of 5.7%.
Some analysts and Fed watchers say policymakers would prefer stocks remain weak as part of their efforts to further tighten financial conditions. Investors may wonder how much wealth destruction the Fed would tolerate in order to destroy demand and quell inflation.
“It’s still open to debate because with the cushion of the stimulus components and the cushion of higher wages that a lot of people have been able to build up over the last few years, demand destruction isn’t going to happen as easily as it would have in the past.” , Fernandez told MarketWatch on Thursday. “Obviously they (the Fed) don’t want to see a complete collapse in equity markets, but as at the press conference [Wednesday], that’s not what they’re looking at. I think they are fine with a little wealth destruction.
BNY Mellon Investment Management’s Meskin worries that there is little chance the economy can successfully achieve a “soft landing,” a term used by economists to refer to an economic slowdown that avoids entering a recession.
“The closer they (the Fed) get to their own projected neutral interest rates, the more they try to calibrate subsequent increases to gauge the impact of each increase as we move into bounded territory,” Meskin said by phone. The neutral interest rate is the level at which the fed funds rate neither raises nor slows economic activity.
“That’s why they’re saying sooner or later they’re going to start raising rates by smaller amounts.” But they also don’t want the market to react in a way that would loosen financial conditions, because any loosening of financial conditions would be inflationary.
Powell said Wednesday that there remains a chance for the economy to escape recession, but that window for soft landing narrowed this year as price pressures ease slowly.
However, investors and Wall Street strategists are divided on whether the stock market has fully priced into the recession, especially given the relatively strong third-quarter results from more than 85 percent of S&P 500 companies that reported, as well as expectations of future earnings.
“I still think if we look at earnings expectations and market pricing, we’re still not pricing in a significant recession,” Meskin said. “Investors are still pricing in a fairly high probability of a soft landing,” but the risk stemming from “very high inflation and the Fed’s own rate hikes is that we’re going to end up having to have much higher unemployment and therefore very lower grades.”
Sheraz Mian, director of research at Zacks Investment Research, said margins are holding up better than most investors would expect. For the 429 S&P 500 members that have already reported results, total earnings rose 2.2% year-over-year, with 70.9% beating EPS estimates and 67.8% beating EPS estimates. the revenue, writes Mian in the article in Friday.
And then there are midterm elections for Congress on November 8.
Investors are debating whether stocks could rally after a fierce battle for control of Congress, as historical precedent points to a trend for stocks to rise after voters go to the polls.
Anthony Saglimbene, chief market strategist at Ameriprise Financial, said markets typically see stock volatility spike 20 to 25 days before an election, then drop in the 10 to 15 days after the results are out.
“We actually saw that this year. When you look from mid to late August to where we are right now, volatility has picked up and is kind of starting to head lower,” Saglimbene said Thursday.
“I think one of the things that has somewhat allowed the markets to put off the midterms is that the chances of a divided government are increasing. In terms of market reaction, we really think the market could react more aggressively to anything outside of a divided government,” he said.