The Federal Reserve isn’t trying to knock the stock market down as it quickly raises interest rates in its bid to slow inflation that’s still red hot — but investors should be prepared for more pain and volatility as policymakers won’t be scared by a deeper sell-off , said investors and strategists.
“I don’t think they’re necessarily trying to lower inflation by destroying stock or bond prices, but it does have that effect.” said Tim Courtney, chief investment officer at Exencial Wealth Advisors, in an interview.
US equities fell sharply last week after hopes of a marked inflation slowdown were thwarted by a higher-than-expected inflation figure in August. The data bolstered expectations among Fed futures traders for a rate hike of at least 75 basis points when the Fed ends its policy meeting on Sept. 21, with some traders and analysts looking for a 100 basis point hike, or a full hike. percentage point.
Example: The Fed is ready to tell us how much ‘pain’ the economy will suffer. However, it still won’t indicate a recession.
The 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,
decreased by 5.5%. The S&P 500 ended Friday below the 3,900 level seen as a key area of tech support, with some chart viewers seeing the potential for a test of the large-cap benchmark’s 2022 low at 3,666.77 on June 16.
To see: Stock market bears see the upper hand while the S&P 500 is below 3,900 . drops
A profit warning from global shipping giant and economic bellwether FedEx Corp. FDX,
further fueled fears of a recession, contributing to Friday’s equity market losses.
Read: Why FedEx’s stock decline is so bad for the entire stock market
Treasuries also fell, with the yield on the 2-year Treasury Note TMUBMUSD02Y,
rising to nearly 15-year highs above 3.85% according to expectations, the Fed will continue to push interest rates in the coming months. Yields rise when prices fall.
Investors operate in an environment where the need for the central bank to curb persistent inflation is widely seen as the idea of a figurative ‘Fed put’ in the stock market has been eliminated.
The concept of a Fed put has been around since the stock market crash in October 1987, which 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 certain level, called the strike price, and serves as an insurance policy against a market decline.
Some economists and analysts have even suggested that the Fed should welcome or even pursue market losses, which could serve to tighten financial conditions as investors cut spending.
Related: Are higher stock prices making 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 won’t be able to get a grip on inflation, which is nearly 40 years high, unless they make investors suffer. “It’s hard to know how much the Federal Reserve will have to do to control 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 hitherto.”
Some market parties are not convinced. Aoifinn Devitt, Chief Investment Officer at Moneta, said the Fed likely sees stock market volatility as a by-product of its efforts to tighten monetary policy, not a target.
“They recognize that stocks can be collateral damage in a tightening cycle,” but that doesn’t mean stocks “should collapse,” Devitt said.
However, the Fed is willing to tolerate markets declining and the economy slowing and even entering recession as it focuses on taming inflation, she said.
The Federal Reserve kept the Fed’s target rate in a range of 0% to 0.25% between 2008 and 2015 as it tackled the financial crisis and its aftermath. The Fed also cut interest rates again to near zero in March 2020 in response to the COVID-19 pandemic. With very low interest rates, the Dow DJIA,
shot up more than 40%, while the large-cap index S&P 500 SPX,
is up more than 60% between March 2020 and December 2021, according to Dow Jones Market Data.
Investors became accustomed to “tailwind for more than a decade of falling interest rates,” as they looked for the Fed to intervene with its “put” should the going get tough, said Courtney of Exencial Wealth Advisors.
“I think (now) the message from the Fed is ‘you’re not going to get this tailwind anymore,'” Courtney told MarketWatch on Thursday. “I think markets can grow, but they will only have to grow because the markets are like a greenhouse where temperatures have to be kept at a certain level all day and all night, and I think that’s the message that markets can and should only grow without the greenhouse effect.”
To see: Opinion: Stock Market Trend Is Relentlessly Bearish, Especially After This Week’s Big Daily Drops
Meanwhile, the Fed’s aggressive stance means investors need to be prepared for what may be a “few more daily stings down” that could eventually turn out to be a “last big flush,” said Liz Young, head of investment strategy at SoFi. a Thursday note.
“This may sound strange, but if that happens quickly, i.e. within the next few months, that really becomes the bull case in my opinion,” she said. “It could be a quick and painful decline, resulting in a renewed uptick later in the year that is more sustainable as inflation falls more noticeably.”