New stock market lows in prospect? What investors need to know as the Fed signals rates will be higher for longer.

Federal Reserve Chairman Jerome Powell has sent a clear signal that interest rates will rise and stay there longer than expected. Investors are wondering if this means further lows for the battered stock market lie ahead.

“If we don’t see inflation starting to come down as the fed funds rate goes up, then we’re not getting to the point where the market can see the light at the end of the tunnel and start to turn around,” , said Victoria Fernandez, chief market strategist at Crossmark Global Investments, “You don’t normally hit the bottom of a bear market until the fed funds rate is above the rate of inflation.”

US stocks initially rallied after the Federal Reserve on Wednesday approved a fourth consecutive 75 basis point hike, taking the federal funds rate to a range between 3.75% and 4%, with a statement that investors interpreted it as a signal that the central bank would deliver smaller rate hikes in the future. However, a more hawkish-than-expected Powell poured cold water on the half-hour market party, sending stocks sharply lower and Treasury yields and federal funds futures higher.

See: What’s next for the markets after the Fed’s 4th consecutive rate hike?

At a press conference, Powell stressed that it was “very premature” to think of a pause in interest rate hikes and said the ultimate level of the fed funds rate would likely be higher than this. that policymakers had predicted in September.

According to the CME FedWatch Tool, the market is now pricing in a more than 66% chance of a rate hike of just half a percentage point at the Fed’s Dec. 14 meeting. This would leave the fed funds rate in a range of 4.25% to 4.5%.

But the big question is how high the rates will ultimately go. In the September forecast, Fed officials had a median of 4.6%, which would indicate a range of 4.5% to 4.75%, but economists are now eyeing a terminal rate of 5% by mid-2023.

Lily: 5 Things We Learned From Jerome Powell’s ‘Whipsaw’ Press Conference

For the first time ever, the Fed also acknowledged that the cumulative tightening of monetary policy could eventually hurt the economy with a “lag”.

It typically takes six to 18 months for rate hikes to pass, strategists said. The central bank announced its first quarter-basis-point hike in March, meaning the economy should start to feel the full effects by the end of this year, and won’t feel the effect. maximum of the fourth 75 of this week. rise in basis points until August 2023.

“The Fed would have liked to see a bigger impact from the tightening until the third quarter of this year on financial conditions and on the real economy, but I don’t think they are seeing enough of an impact,” said Sonia Meskin. , head of US macroeconomics at BNY Mellon Investment Management. “But they don’t want to inadvertently kill the economy either…that’s why I think they’re slowing the pace.”

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Mace McCain, chief investment officer at Frost Investment Advisors, said the main goal was to wait for the maximum effects of rate hikes to trickle down to the labor market, as higher interest rates push prices higher. houses, followed by more inventory and less construction, fueling a less resilient labor market.

However, government data on Friday showed the US economy gained a surprisingly strong 261,000 new jobs in October, beating a Dow Jones estimate of 205,000 additions. Perhaps more encouraging for the Fed, the unemployment rate rose from 3.5% to 3.7%.

U.S. stocks ended sharply higher in a volatile trading session on Friday as investors weighed what a mixed jobs report meant for future Fed rate hikes. But major indexes posted weekly declines, with the S&P 500 SPX,
+1.36%
down 3.4%, the Dow Jones Industrial Average DJIA,
+1.26%
down 1.4% and the Nasdaq Composite COMP,
+1.28%
shows a decrease of 5.7%.

Some analysts and Fed watchers have argued that policymakers would prefer stocks to remain weak as part of their efforts to further tighten financial conditions. Investors may wonder what destruction of wealth the Fed would tolerate to destroy demand and stifle inflation.

“It’s still open to debate because with the cushion of stimulus items and the higher wage cushion that a lot of people have been able to get over the last couple of years, demand destruction won’t happen as easily as it would have in the past,” Fernandez told MarketWatch on Thursday. “Obviously they (the Fed) don’t want to see the stock markets totally crash, but like in the press conference [Wednesday], that’s not what they’re looking at. I think they’re okay with a little wealth destruction.

Related: Here’s why the Federal Reserve let inflation rise to its highest level in 40 years and how it rattled the stock market this week

BNY Mellon Investment Management’s Meskin feared there was only a slim chance the economy would pull off a “soft landing” – a term economists use to refer to an economic downturn that avoids tipping into recession.

“The closer they (the Fed) get to their own estimated neutral rates, the more they try to calibrate subsequent increases to gauge the impact of each increase as we move into restricted territory,” Meskin said by phone. The neutral rate is the level at which the federal funds rate neither stimulates nor slows down economic activity.

“That’s why they’re saying they’re going to start increasing rates in small amounts as soon as possible. But they also don’t want the market to react in a way that would ease financial conditions, because any easing of financial conditions would be inflationary.

Powell said Wednesday there remained a chance the economy could escape a recession, but that window for a soft landing has narrowed this year as price pressures have been slow to ease.

However, investors and Wall Street strategists are divided on whether the stock market has fully priced in a recession, especially given relatively strong third-quarter results from more than 85% of S&P 500 companies that have published information as well as earnings forecasts.

“I still think if we look at earnings expectations and market prices, we’re not really pricing in a significant recession right now,” Meskin said. “Investors still attribute a reasonably high probability to a soft landing,” but the risk from “very high inflation and a terminal rate hike by the Fed’s own estimates is that ultimately, we’re going to have to have much higher unemployment and therefore much lower valuations.” .””

Sheraz Mian, director of research at Zacks Investment Research, said margins are holding up better than most investors would have expected. For the 429 members of the S&P 500 that have already reported results, total revenue rose 2.2% from the same period last year, with 70.9% beating EPS estimates and 67 .8% revenue estimates, Mian wrote in a Friday post.

And then there are the midterm congressional elections on November 8.

Investors are wondering if stocks can gain ground following a fierce battle for control of Congress, as historical precedent points to a rising trend in stocks after voters head to the polls.

See: What Midterms Mean for the Stock Market’s ‘Best Six Months’ as the Favorable Calendar Period Sets in

Anthony Saglimbene, chief market strategist at Ameriprise Financial, said markets typically see equity volatility spike 20 to 25 days before the election and then drop within 10 to 15 days after the results are released.

“We have actually seen that this year. When you look from mid and late August where we are right now, the volatility has gone up and it kind of starts to come down,” Saglimbene said on Thursday.

“I think one of the things that kind of allowed the markets to push back the midterm elections is that the chances of a divided government are increasing. In terms of market reaction, we really think that the market may react more aggressively to anything outside of a divided government,” he said.

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