Can the Fed tame inflation without further crushing the stock market? What’s next for investors.

The Federal Reserve isn’t trying to hit the stock market as it quickly raises interest rates in its bid to curb still-simmering inflation, but investors should be prepared for more pain and volatility as political leaders will not be limited. for a deeper selloff, investors and strategists said.

“I don’t think they’re necessarily trying to reduce inflation by destroying stock or bond prices, but it’s having that effect.” Tim Courtney, chief investment officer at Exencial Wealth Advisors, said in an interview.

US stocks fell sharply last week after hopes of a sharp cooling in inflation were dashed by a hotter-than-expected inflation reading in August. The data bolstered expectations among fed funds futures traders for a rate hike of at least 75 basis points when the Fed concludes its policy meeting on Sept. 21, with some traders and analysts looking for a hike in 100 basis points, or a full percentage. point.

Preview: The Fed is willing to tell us how much “pain” the economy will suffer. However, it still won’t signal a recession.

The Dow Jones Industrial Average DJIA,
posted a weekly drop of 4.1%, while the S&P 500 SPX,
fell 4.8% and the Nasdaq Composite COMP,
suffered a decline of 5.5%. The S&P 500 ended Friday below the 3,900 level seen as a major area of ​​technical support, with some chart watchers eyeing a potential test of the large-cap benchmark’s 2022 low at 3,666.77 set on June 16

I will see: Stock market bears seen holding top position as S&P 500 slips below 3,900

A profit warning from global shipping giant and economic promoter FedEx Corp. FDX,
further fueled recession fears, contributing to Friday’s stock market losses.

Reads: Why FedEx’s stock drop is so bad for the entire stock market

Treasuries also fell, with the yield on the 2-year Treasury note TMUBMUSD02Y,
rising to a near 15-year high above 3.85% on expectations that the Fed will continue to raise rates in the coming months. Yields rise as prices fall.

Investors operate in an environment where the central bank’s need to curb stubborn inflation has largely seen the notion of a figurative “Fed put” in the stock market removed.

The concept of a Fed put has been around at least since the October 1987 stock market crash prompted the Alan Greenspan-led central bank to lower interest rates. A real put option is a financial derivative that gives the holder the right, but not the obligation, to sell the underlying asset at a certain level, known as the strike price, which serves as an insurance policy against a market crash.

Some economists and analysts have even suggested the Fed should welcome or even target market losses, which could serve to tighten financial conditions as investors cut spending.

Related: Do higher stock prices make it harder for the Fed to fight inflation? The short answer is “yes”

William Dudley, the former president of the New York Fed, argued earlier this year that the central bank will fail to control inflation near 40-year highs unless it makes investors suffer. “It’s hard to know how much the Federal Reserve will need to do to control inflation,” 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 participants 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 that stocks can be collateral damage in a tightening cycle,” but that doesn’t mean stocks “need to collapse,” Devitt said.

The Fed, however, is prepared to tolerate markets declining and the economy slowing and even falling into recession as it focuses on taming inflation, he said.

The Federal Reserve kept the target fed funds 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 rates to near zero in March 2020 in response to the COVID-19 pandemic. With very low interest rates, the Dow DJIA,
soared more than 40%, while the large-cap S&P 500 SPX,
rose 60% between March 2020 and December 2021, according to Dow Jones Market Data.

Investors have gotten used to “more than a decade of headwinds with falling interest rates” as they looked for the Fed to step in with its “put” if the going got tough, Courtney told Exential Wealth Advisors.

“I think (now) the message from the Fed is ‘you’re not going to have that tailwind anymore,'” Courtney told MarketWatch on Thursday. “I think the markets can grow, but they’re going to have to grow on their own because the markets are like a greenhouse where temperatures have to stay at a certain level all day and all night, and I think that’s the message that markets can and should grow on their own without the greenhouse effect.”

I will see: Opinion: The stock market trend is relentlessly bearish, especially after this week’s big daily declines

Meanwhile, the Fed’s aggressive stance means investors should be prepared for what may be “a few more daily stabs to the downside” that could ultimately turn out to be a “last big flow,” said Liz Young, head of SoFi’s investment strategy, on a Thursday. note

“This may sound strange, but if this happens quickly, meaning in the next couple of months, this will become the bull case in my view,” he said. “It could be a quick and painful fall, resulting in a renewed move higher later in the year that is more durable as inflation falls more markedly.”

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