The Federal Reserve isn’t trying to slam the stock market as it quickly raises interest rates in its bid to curb inflation, which is still running red-hot — but investors should be prepared for more pain and volatility because policymakers won’t be cowed by a deeper selloff, said investors and strategists.
“I don’t think they’re necessarily trying to drive down inflation by destroying stock prices or bond prices, but it does have 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 significant cooling in inflation were dashed by a warmer-than-expected inflation reading in August. The data cemented expectations among Fed 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 looking for a 100-basis-point hike or a full percentage point. point.
Example: The Fed is ready to tell us how much ‘pain’ the economy will suffer. However, that still won’t suggest recession.
Dow Jones Industrial Average DJIA,
recorded a weekly decline of 4.1%, while the S&P 500 SPX,
fell 4.8% and the Nasdaq Composite COMP,
experienced a decrease of 5.5 per cent. The S&P 500 ended Friday below the 3,900 level, considered a key area of technical support, with some chart-watchers eyeing the potential for a test of the 2022 large-cap benchmark at 3,666.77 set on June 16.
See: Stock market bears are seen holding the upper hand as the S&P 500 falls below 3,900
A profit warning from global shipping giant and economic bellwether FedEx Corp. FDX,
further fueled recession fears, contributing to stock market losses on Friday.
Read: Why FedEx’s stock decline is so bad for the entire stock market
Treasurys also fell with yields on the 2-year Treasury note TMUBMUSD02Y,
floating to a near 15-year high above 3.85% on expectations that the Fed will continue to push interest rates up in the coming months. Dividends increase as prices fall.
Investors are operating in an environment where the central bank’s need to rein in stubborn inflation is seen largely after eliminating the notion of a figurative “Fed put” in the stock market.
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. A real put option is a financial derivative that gives the holder the right, but not the obligation, to sell the underlying asset at a certain level, known as the strike price, which serves as insurance against a market decline.
Some economists and analysts have even suggested that the Fed should welcome or even target market losses, which could serve to tighten financial conditions as investors scale back spending.
Related: Do higher stock prices make it harder for the Fed to fight inflation? The short answer is ‘yes’
William Dudley, the former president of the New York Fed, argued earlier this year that the central bank will not get a handle on inflation, which is near 40-year highs, unless they make investors suffer. “It’s hard to know how much the Federal Reserve will need to do to get inflation under control,” 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 before.”
Some market participants are not convinced. Aoifinn Devitt, investment manager at Moneta, said the Fed likely sees stock market volatility as a byproduct of its efforts to tighten monetary policy, not a goal.
“They recognize that stocks can be collateral damage in a tightening cycle,” but that doesn’t mean stocks “need to collapse,” Devitt said.
However, the Fed is prepared to tolerate markets falling and the economy slowing and even tipping into recession as it focuses on taming inflation, she said.
The Federal Reserve kept the target fed funds rate 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 a bottom rate, the Dow DJIA,
soared over 40%, while the large-cap S&P 500 SPX,
jumped over 60% between March 2020 and December 2021, according to Dow Jones Market Data.
Investors were getting used to the “tailwinds of more than a decade of falling interest rates” as they looked for the Fed to step in with its “put” should it stall, said Courtney of Exencial Wealth Advisors.
“I think (now) the Fed’s message is ‘you’re not getting this tailwind anymore,'” Courtney told MarketWatch on Thursday. “I think markets can grow, but they will have to grow on their own, because markets are like a greenhouse where the temperatures have to be kept at a certain level all day and all night, and I think it’s the message that markets can and should grow on their own without the greenhouse effect.”
See: Opinion: The trend in the stock market is relentlessly bearish, especially after this week’s big daily decline
Meanwhile, the Fed’s aggressive stance means investors should be prepared for what could be a “few more daily stabs to the downside” that could ultimately turn out to be a “last big flush,” said Liz Young, head of investment strategy at SoFi, on a Thursday. Note.
“It might sound strange, but if it happens quickly, meaning within the next few months, it’s actually going to be a bull case in my opinion,” she said. “It could be a quick and painful decline, resulting in a renewed rise later in the year that is more sustainable as inflation falls more significantly.”