Heading into this week’s Federal Reserve meeting, all of the hawkish policy surprises are finally out of the bag. Meanwhile, the inflation rate has likely peaked. Yet the Dow Jones is back in correction territory, the S&P 500 just closed at its lowest point of the year, and a Nasdaq bear market has resumed.
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Markets fully expect policymakers to announce a half-point rate-hike when this week’s Federal Reserve meeting wraps up on Wednesday at 2 p.m. ET. And that’s expected to be followed by more of the same — if not an even bigger hike — in the next two Fed meetings. Since the March 15-16 Federal Reserve meeting, Fed chief Jerome Powell has talked about moving “expeditiously” to tighten, and “front-end loading” policy moves.
On that score, the Fed also has made clear that it is set to begin unwinding $4.5 trillion in asset purchases made during the pandemic. Fed balance-sheet runoff, known as quantitative tightening or QT, will ramp up to a $95-billion monthly pace over three months, minutes from the March meeting indicated.
The setup looks well-suited for the Dow Jones and broader stock market to rally. “Our basic thesis here is that we are due for a relief rally because the market expects 50-basis points, QT, this front-end loading process. And inflation has peaked on the goods side,” Ironsides Macroeconomics managing partner Barry Knapp told clients on Sunday.
A slower pace of rate hikes as the midterm elections near should also be conducive to a relief rally, Knapp said.
So what could go wrong? If there’s a risk at the coming meeting, it likely comes from Powell’s post-meeting news conference.
Where Is Fed Put For Dow Jones?
When the Federal Reserve last combined rate hikes with balance-sheet tightening, the stock market tanked in the fall of 2018, flirting with bear-market territory. The Dow Jones fell 19.5% from the October 2018 peak to December’s trough. Over the same period, the S&P 500 fell as much as 20% and the Nasdaq 24%.
Powell alluded to that history at his news conference following last December’s Fed meeting. “In dealing with balance sheet issues, we’ve learned that it’s best to take a careful sort of methodical approach. Markets can be sensitive to it.”
Powell was asked in September 2018 what it would take for the Fed to respond to financial market weakness. His answer: “a significant correction and lasting correction.”
In fact, the fall 2018 market sell-off helped sparked a policy rethink at the time. In early January 2019, the Fed signaled retreat. By fall, rate hikes turned to rate cuts and the Fed renewed bond purchases. However, it was a pretty simple matter for the Fed to backpedal in early 2019 because inflation was tame.
If asked again, the big question now is whether Powell’s answer would be the same. Likely not. So the stock market reaction this week may depend on how gracefully Powell dances around that question.
A put option gives investors downside protection if a stock falls below a certain price. There’s certainly some stock market level and some economic circumstances that would spur Powell and other policymakers to ride to the rescue.
Is A Weak Stock Market Part Of Fed’s Plan?
As Powell explained at his March 16 news conference following the latest Federal Reserve meeting, monetary policy “reaches the real economy” by changing financial conditions, such as market-based interest rates and stock prices.
As of Friday’s close, the Dow had fallen 10.3% from its all-time closing high. The S&P 500 had lost nearly 14% and the Nasdaq 23%. Except for the Nasdaq, this sell-off isn’t close to levels that spurred a policy rethink at the start of 2019.
The Dow Jones and other major indexes sold off again intraday Monday, with the S&P 500 index joining the Nasdaq in undercutting its 2022 lows as the 10-year Treasury yield briefly touched 3% for the first time since 2018. But the major indexes rebounded off lows heading into the close, with the Dow and S&P 500 slashing losses and the Nasdaq turning positive.
The Fed doesn’t directly target any level for the stock market. However, it’s fair to say that a rising Dow Jones would work against the Fed’s goal to tighten financial conditions.
Further, recent commentary from Fed vice chair Lael Brainard highlighted inflation as particularly insidious for low-income Americans. That suggests policymakers may see the trade-off of lower stock prices to tame the scourge of inflation as enhancing equality.
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Source: https://www.investors.com/news/economy/federal-reserve-meeting-will-peak-hawkishness-spark-dow-jones-relief-rally/?src=A00220&yptr=yahoo