New stock market lows ahead? What investors need to know as Fed signals rates will be higher for longer.

Federal Reserve Chairman Jerome Powell sent a clear signal that interest rates will move higher and stay there longer than expected. Investors wonder if that means new lows for the stock market are ahead.

“If we don’t see inflation starting to fall as the fed funds rate goes up, we’re not getting to the point where the market can see the light at the end of the tunnel and start to turn around ,” said Victoria Fernandez, chief market strategist at Crossmark Global Investments. “You don’t usually hit the bottom in a bear market until the fed funds rate is higher than the inflation rate.”

US stocks rallied first after the Federal Reserve on Wednesday approved its fourth consecutive 75 basis point hike, pushing the fed funds rate to a range of 3.75% to 4%, in a statement that investors saw as a sign that the smaller central bank. future rate increases. However, Powell’s more-than-expected comments poured cold water over the half-hour market party, sending stocks sharply lower and Treasury yields and fed funds futures higher.

look: What’s next for markets after the Fed’s 4th straight jumbo rate hike

In a news conference, Powell stressed that it was “very early” to consider a pause in interest rate hikes and said that the final level of the federal funds rate was likely to be higher than policymakers had expected in May. Autumn.

The market is now pricing in a more than 66% chance of a half percentage point rate hike at the Fed’s Dec. 14 meeting, according to CME’s FedWatch Tool. That would make the fed funds rate between 4.25% and 4.5%.

But the bigger question is how high rates will eventually go. In the September forecast, Fed officials averaged 4.6%, suggesting a range of 4.5% to 4.75%, but economists are now penciling in a terminal rate of 5% by mid-2023.

Read: 5 things we learned from Jerome Powell’s press conference on the ‘whipsaw’

For the first time ever, the Fed also acknowledged that the cumulative tightening of monetary policy could hurt the economy with a “delay.”

It usually takes six to 18 months to get the rate hikes, strategists said. The central bank announced its first fourth quarter rate hike in March, which means the economy should be starting to feel some of those full effects by the end of this year, and not feel the biggest effect. of this week’s quarter 75. basis point promotion until August 2023.

“The Fed would like to see a bigger impact from the tightening through Q3 this year on financial conditions and the real economy, but I don’t think they’re seeing 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 … and that’s why I think they’re slowing down.”

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Mace McCain, chief investment officer at Frost Investment Advisors, said the main goal is to wait until the maximum effects of rate hikes are transferred to the labor market, as higher interest rates lead to higher home prices, and then that’s more inventory and less construction, which provides fuel. a less resilient labor market.

However, government data on Friday showed the US economy gained a surprisingly strong 261,000 new jobs in October, beating the Dow Jones estimate of 205,000 additions. Perhaps more encouraging for the Fed, the unemployment rate rose to 3.7% from 3.5%.

US stocks ended much 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, with the S&P 500 SPX,
+1.36%
down 3.4%, the Dow Jones DJIA industrial average,
+1.26%
fell 1.4% and the Nasdaq Composite COMP,
+1.28%
suffering a decrease of 5.7%.

Some analysts and Fed watchers have argued that policymakers would prefer that equities remain weak as part of their effort to tighten financial conditions. Investors may be surprised by the destruction of wealth that the Fed could endure to destroy demand and remove inflation.

“It is still open for debate that due to the softening of the incentive components and the reduction in higher wages that many people have been able to collect over the last few years, the deletion of demands will not happen as easily as it would. in the past,” Fernandez told MarketWatch on Thursday. “Clearly they (Fed) don’t want to see equity markets collapse, but as happened in the press conference. [Wednesday], that’s not what they’re looking for. I think they’re okay with a little destruction of wealth.”

Related: Here’s why the Federal Reserve let inflation hit a 40-year high and how it affected the stock market this week

Meskin of BNY Mellon Investment Management worried that there is little chance that the economy could achieve a successful “soft landing” – a term economists use to denote an economic slowdown that avoids recession.

“The closer they (Fed) get to their own estimated neutral rates, the more they try to calibrate subsequent increases to assess the impact of each increase as we move into restrained territory,” Meskin said on the phone. The neutral rate is the level at which the fed funds rate neither accelerates nor decelerates economic activity.

“This is why they are saying they are going to start, sooner rather than later, raising rates less. But they don’t want the market to work in a way that would loosen financial conditions because any loosening of financial conditions would be inflationary.”

Powell said Wednesday that there is still a chance the economy can escape a recession, but that window for a soft landing has narrowed this year as price pressures have been slow to ease.

However, some Wall Street investors and strategists question whether the stock market is fully priced in during a recession, especially given relatively strong third-quarter results from more than 85% of S&P 500 companies that also reported with forward-looking earnings expectations.

“I still think if we look at earnings expectations and market pricing, we don’t really price in a significant recession yet,” Meskin said. “Investors are still assigning a relatively high probability of a soft landing,” but the risk from “very high inflation and the final rate according to the Fed’s own estimates moving higher is that we will end up with much higher unemployment finally have and therefore much lower valuations. .””

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 index members that have already reported results, total earnings are up 2.2% from the same period last year, with 70.9% beating EPS estimates and 67.8% beating revenue estimates, Mian wrote in an article Friday.

And then there are the congressional midterm elections on November 8th.

Investors are debating whether stocks can gain ground after a closely fought battle to control Congress since historical precedent shows that stocks tend to rise after voters go to the polls.

Look: What the medium term means for the stock market’s ‘best 6 months’ as the calendar stretches out favorably

Anthony Saglimbene, chief market strategist at Ameriprise Financial, said markets typically see stock volatility spike 20 to 25 days before an election, then move lower in the 10 to 15 days after the results are in. .

“We’ve seen that this year. When you look from the middle to the end of August into where we are now, the volatility has increased and it’s kind of starting to get worse,” Saglimbene said Thursday.

“I think one of the things that has allowed the markets to push back the mid-term elections is that the chances of a divided government are increasing. In terms of market reaction, we really think the market could react more sharply to anything outside of a divided government,” he said.

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