Can the Fed rein in inflation without further crushing the stock market? What investors need to know.

By Isabelle Wang

Investors should brace for more volatility as policymakers set for another giant rate hike

The Federal Reserve isn’t trying to slam the stock market as it rapidly raises interest rates in its bid to slow ever-burning inflation – but investors should be prepared for more pain and volatility as policymakers politicians won’t be intimidated by a sell-off, investors and strategists said.

“I don’t think they’re necessarily trying to drive down inflation by destroying stock or bond prices, but it has 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 sharp slowdown in inflation were dashed by a stronger-than-expected August inflation reading. The data cemented fed funds futures traders’ expectations for a rate hike of at least 75 basis points when the Fed concludes its policy meeting on September 21, with some traders and analysts looking for a 100 basis point increase, or a full percentage. indicate.

Preview:The Fed is ready to tell us how badly the economy will suffer. It still won’t hint at the recession

The Dow Jones Industrial Average recorded a weekly decline of 4.1%, while the S&P 500 fell 4.8% and the Nasdaq Composite fell 5.5%. The S&P 500 ended Friday below the 3,900 level seen as an important area of ​​technical support, with some chart watchers eyeing the possibility of a test of the large-cap benchmark’s 2022 low at 3,666. .77 set June 16.

See: Stock markets seem to hold the upper hand as the S&P 500 falls below 3,900

A profit warning from global shipping giant and economic indicator FedEx Corp. (FDX) further stoked recession fears, contributing to stock market losses on Friday.

Read: Why the FedEx stock plunge is so bad for the overall stock market

Treasuries also fell, with the yield on 2-year Treasuries hitting a nearly 15-year high above 3.85%, on expectations that the Fed will continue to hike rates in the months ahead. coming. Yields increase as prices fall.

Investors are operating in an environment where the central bank’s need to rein in stubborn inflation is widely seen as having eliminated 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 central bank led by Alan Greenspan to cut interest rates. A real put option is a financial derivative that gives its holder the right but not the obligation to sell the underlying asset at a defined level, called the strike price, serving as an insurance policy against a decline in the price. market.

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 cut spending.

Related: Are rising stock prices making it harder for the Fed to fight inflation? The short answer is yes’

William Dudley, the former chairman of the New York Fed, argued earlier this year that the central bank would not be able to rein in inflation which is nearing a 40-year high unless it hurt investors . “It’s hard to know 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 will have to inflict more losses on stock and bond investors than it has so far.”

Some market players are not convinced. Aoifinn Devitt, chief investment officer 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 stocks can be collateral damage in a tightening cycle,” but that doesn’t mean stocks “have to crash,” Devitt said.

The Fed, however, is prepared to tolerate seeing markets decline and the economy slow and even tip into recession as it focuses on controlling inflation, she said.

Recent: Fed’s Powell says cutting inflation will hurt households and businesses in Jackson Hole speech

The Federal Reserve kept the target federal funds rate within 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 rates to near zero in March 2020 in response to the COVID-19 pandemic. With interest rates at rock bottom, the Dow Jones climbed more than 40%, while the large-cap S&P 500 index jumped more than 60% between March 2020 and December 2021, according to Dow Jones Market Data. .

Investors have become accustomed to “tailwinds for more than a decade with lower interest rates” while looking for the Fed to step in with its “put” if things get tough, Courtney said at Exencial Wealth Advisors.

“I think (now) the message from the Fed is ‘you won’t have that 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 temperatures have to be kept at a certain level all day and night, and I think this is the message that markets can and must push on their own without the greenhouse effect.”


Meanwhile, the Fed’s aggressive stance means investors need to be prepared for what could be “a few more daily knocks down” that could eventually turn out to be a “big wave finale,” Liz Young said, head of investment strategy at SoFi, in a Thursday. Remark.

“It may sound strange, but if it happens quickly, meaning within the next couple of months, it actually becomes bull’s case in my opinion,” she said. “It could be a quick and painful decline, leading to a further rise later in the year that is more sustainable as inflation falls more significantly.”

-Isabel Wang


(END) Dow Jones Newswire

09-17-22 1636ET

Copyright (c) 2022 Dow Jones & Company, Inc.

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