By Isabel Wang
Investors should brace for more volatility as policymakers expect another massive rate hike
The Federal Reserve isn’t trying to beat the stock market as it quickly raises interest rates to curb inflation, which is still running hot — but investors need to be prepared for more pain and volatility because policymakers won’t cowed by a deepening sell-off, investors and strategists said.
“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 stocks fell sharply last week after hopes of a significant slowdown in inflation were dashed by hotter-than-expected August inflation. The data cemented expectations among fed funds futures traders for a rate hike of at least 75 basis points when the Fed concludes its Sept. 21 monetary policy meeting, with some traders and analysts expecting a 100 basis point hike, or a full percentage point .
Preview: The Fed is ready to tell us how much “pain” the economy will suffer. However, it still will not portend a recession
The Dow Jones Industrial Average was down 4.1% weekly, while the S&P 500 was down 4.8% and the Nasdaq Composite was down 5.5%. The S&P 500 closed below the 3,900 level on Friday, seen as a key area of technical support, with some chart watchers seeing the potential for a test of the large-cap benchmark’s 2022 low of 3,666.77 posted on June 16.
Behold: Stock market bears prevail as S&P 500 falls below 3,900
A profit warning from global shipping giant and business leader FedEx Corp. (FDX) continued to stoke recession fears and contributed to stock market falls on Friday.
Read: Why FedEx’s Stock Drop Is So Bad for the Overall Stock Market
Treasuries also fell, with the yield on the 2-year Treasury note rising to a near 15-year high of over 3.85% on expectations that the Fed will continue to hike rates in the coming months. Yields rise when prices fall.
Investors are operating in an environment where the central bank’s need to rein in stubborn inflation is widely recognized, having removed the notion of a figurative “Fed put” from the stock market.
The concept of a Fed put has been around since at least the October 1987 stock market crash, 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 specified price, called the strike price, which serves as an insurance policy against a market downturn.
Some economists and analysts have even suggested that the Fed should welcome, or even seek, market losses, which could lead to tighter financial conditions as investors rein in spending.
Related: Are higher stock prices making it harder for the Fed to fight inflation? The short answer is ‘yes’
William Dudley, former New York Fed President, argued earlier this year that if the central bank doesn’t make investors suffer, it won’t contain inflation, which is nearing a 40-year high. “It’s hard to gauge how much the Federal Reserve will have to do to get inflation under control,” Dudley wrote in a Bloomberg column in April. “But one thing is certain: to be effective, it must inflict more losses on stock and bond investors than it has so far.”
Some market participants are not convinced. Aoifinn Devitt, Moneta’s chief investment officer, said the Fed likely views stock market volatility as a by-product of its efforts to tighten monetary policy, rather than as a goal.
“You 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 willing to tolerate a fall in markets, a slowdown in the economy and even slide into recession as it focuses on taming inflation, she said.
Recently: The Federal Reserve’s Powell says in a Jackson Hole speech that bringing inflation down will hurt households and businesses
The Federal Reserve left the Fed Funds target 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 again to almost zero in March 2020 in response to the COVID-19 pandemic. With interest rates bottoming, the Dow rose over 40% between March 2020 and December 2021, according to Dow Jones Market Data, while the large-cap S&P 500 index rose over 60%.
Investors have become accustomed to “the tailwind for over a decade of falling interest rates” while waiting for the Fed to “put” in if things get tough, said Courtney of Exencial Wealth Advisors.
“I think[now]the message from the Fed is, ‘You’re not going to get that tailwind anymore,'” Courtney told MarketWatch on Thursday. “I think markets can grow but they have to grow on their own because 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, which the markets can and should grow under their own steam without the greenhouse effect.”
Meanwhile, the Fed’s aggressive stance means investors should be prepared for “a few more daily moves down” that could eventually prove to be the “last big flush,” Liz Young, SoFi’s head of investment strategy, said on a Thursday note .
“It might sound strange, but if that happens quickly, meaning within the next few months, that’s actually going to be a bull case from my perspective,” she said. “It could be a quick and painful pullback, leading to a rebound later in the year that’s more durable as inflation falls more significantly.”
– Isabel Wang
(ENDS) Dow Jones Newswires
Copyright (c) 2022 Dow Jones & Company, Inc.