Fed rate hike closed; Here’s what will drive the markets

The preparation for the conclusion of the Fed meeting tomorrow looks promising for the continuation of the recent rise in the Dow Jones Industrial Average. The rate has already been raised for the second time in a row by 75 basis points, so the stock market’s reaction to Wednesday’s monetary policy comments should hinge on what Fed Chair Jerome Powell refers to about the September meeting, about two months away.


Inflation appears to have finally passed its peak, with prices for gas and other commodities lower. Meanwhile, a batch of unexpectedly weak economic data began to pile up. Thursday morning’s release of back-to-back GDP may include chapters of negative growth, if the White House’s denial of recession is evidence. Against this backdrop, moderating the pace of the Fed’s rate hike to half a point in September makes sense.

However, market prices are still pointing to a 50% chance of a third straight rise of 75 basis points on September 21, according to CME Group’s FedWatch page. The Fed’s guidance suggests a still massive half-point move that would amount to easier-than-expected policy and should be enough to keep investors capped.

So what can – and may fail – go wrong for those who are betting on an ongoing stock market bounce with the help of this week’s Federal Reserve meeting?

Right now, inflation is still too high and unemployment is too low for the Fed to cushion the economy’s downturn. In addition, Federal Reserve officials are always looking at how markets will react to monetary policy changes. At this point, they will likely see the Dow’s rally as premature, as it will work against their efforts to cool demand through tighter financial conditions. So they may be careful not to give investors reasons to be optimistic in the near term.

Unexpected Fed pivot?

Wall Street strategists increasingly expect the Federal Reserve to shift to a slower rate hike. With sluggish growth turning into a row with a recession, the Fed is seen pausing interest rate hikes. By the spring of 2023, a rate cut may be on the table. The rise of the dollar against foreign currencies, which has already contributed to the tightening of financial conditions, is an essential part of their thesis. A strong dollar may lower the Fed’s interest rate ceiling in this cycle.

While the bullish pivot scenario makes some sense, the Fed may surprise with a different type of pivot. Recently, Powell has stressed the importance of top-line inflation, including volatile food and energy prices, as the most convenient for consumers. This makes sense, because if gas and grocery bills jump, workers may be more determined to pay for larger wage increases. These large wage increases, in turn, may force firms to pass on labor inflation via higher prices to their customers.

But now that the surge in gas prices and, to some extent, food prices have subsided, Powell may shift focus to a component of inflation that has yet to show any progress. The June CPI report showed that prices for non-energy services — categories like rent, medical services and transportation that account for 57% of household budgets — rose 5.5% from a year ago, the highest inflation since 1991.

This type of inflation is seen as more constant, as it is less subject to supply fluctuations and more correlated with wage growth. Powell said the Fed needs to see inflation and inflation pressures ease in a convincing way. The ongoing service inflation shows that there is a lot of work to be done.

Recession blame

The Fed is supposed to take a look at Thursday’s GDP report before policy decisions on Wednesday. Won’t consecutive quarters of negative GDP growth pressure the Fed to slow the rate hike path?

not necessarily. The Fed can make a good argument that real growth is negative only because inflation is so high. WalmartA earnings warning (WMT) on Monday suggested something similar, with the company saying comparable sales growth would be higher than expected.

Powell might say lowering inflation is the key to turning nominal spending increases into real ones.

Even the Fed’s unlikely soft landing forecast released in June envisions the unemployment rate rising to 4.1%. It now stands at 3.6%, near its lowest level in half a century. The Fed sees rising unemployment as part of the process of tackling inflation, not something to be avoided.

There may also be talk about whether the Fed’s key interest rate is truly in neutral territory. It is set to rise to the 2.25%-2.5% range. Policy makers believe the long-term neutral rate is around 2.4%. It assumes that inflation returns to its target. As long as the Fed’s benchmark interest rate is negative in real terms – less than the inflation rate – it can still be said to be appropriate.


One of the keys to the upside is the idea that the Federal Reserve has regained its anti-inflation credibility with consecutive hikes of 75 basis points. If the Fed does not have to be concerned about expectations of higher inflation, policy makers should feel some flexibility to raise at a more moderate pace, adjusting as needed.

However, it may be too soon for the Fed to let up on its guard even a bit. The biggest spread of inflation since the 1980s involves a lot of wild cards outside the Fed’s control. That includes everything from Russia’s invasion of Ukraine to pandemic-related lockdowns. Policymakers will not take their luck at last for granted.

In addition, Powell notes that the forces that hold back inflation in recent decades have been pushing in the other direction. Most notably the demographics of the workforce and globalization.

Prepared by Dow Jones

The Dow was down 0.7% Tuesday after Walmart’s warning Monday night. With that said, the Dow is still up 6.3% from its June 17 closing low. That cut its loss to just 13.7% from its closing high on January 4th. The S&P, despite falling 1.2% on Tuesday, has recovered 6.9% of its losses and now stands at 18.25% from its closing peak. The Nasdaq, although down 1.9% during the session, enjoyed an 8.6% retracement, but it is still below its 28% peak.

The rise came as the 10-year Treasury yield fell, after rising nearly 3.5%. It is now approaching 2.8% as investors anticipate a further slowdown amid the Fed’s tightening, eventually leading to a rate cut.

In late 2018, all it took was a 20% market dip for the Fed to end its program of rate hikes and tighten the balance sheet. By the fall of 2019, the Fed was cutting interest rates and buying more assets. But inflation was below target at the time, and not at a high intergenerational level.

The Dow and other major indexes broke above the 50-day lines for the first time since April. This reflects optimism about the Fed pivot, but bullish trends are currently under pressure. Be sure to read the IBD’s daily big picture column after each trading day to stay on top of the market direction and what that means for your trading decisions.

Please follow Jade Graham on Twitter Tweet embed To cover economic policy and financial markets.

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