The Reserve Will Not Reverse Course. Powell Won’t Save Market

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One of the most popular topics of discussion among Fed watchers, from Wall Street to economists and beyond, is whether the Federal Reserve would change course from its current trajectory of raising interest rates to combat inflation.

It may be referred to as “pivot chatter.” How likely is it that the central bank would abandon its efforts to rein in the most significant price hikes in forty years? What does this mean for stocks?

Only once the first issue has been addressed and clarified can the second question have an answer.

First, there is a significant risk that Fed officials, including Chairman Jerome Powell, won’t finish what they’ve begun. Even more audaciously than observers had anticipated, they had increased interest rates five times in the last six months. A half-point rise followed a quarter-point increase in March in May and three-quarters of a percentage-point increase in June, July, and September.

Then why? Since there are indications that what they’re doing is indeed effective. If the data are accurate, the economy is beginning to slow.

The manufacturing industry is slowing down first. Monday saw lower-than-expected U.S. data for September. To be sure, manufacturing still expanded, but at a rate that was the lowest since May 2020 and over two percentage points lower than in August. Businesses are preparing for decreased demand.

On Tuesday, statistics on job opportunities were released. Even while the figure for August was a robust 10.1 million, it was nearly a million lower than it had been the previous month, which is just another sign of declining economic demand.

Although it is slowing down, the economy is still rising. Jobs figures decline before rising. Still on fire is inflation. And there is no doubt that the inflation rate is the most crucial indicator. The Federal Reserve’s target yearly rate is 2%, and this objective keeps the institution on course.

Now, Powell has also discussed jobs frequently. Since rising unemployment often accompanies recessions, he wants the job market to loosen up. A slump is acceptable to the central bank if it lowers inflation.

So far, so good in the employment market, yet Friday’s data might represent a turning point. Next week brings the inflation data for September.

The effects of this have been disastrous for bonds and stocks. Investors attempt to interpret the signals, which can be risky when the indications disagree.

Because of concern over inflation and what the Fed is doing, stocks and bonds have experienced significant swings—down and up, respectively.

The S&P 500SPX -1.02%, the Nasdaq COMP -0.68%, and the Dow DJIA -1.15% are now in bear markets. A bear market is considered a decline of at least 20% in the S&P 500 that has occurred since its all-time high in early January.

The Fed last increased interest rates in late 2018. The S&P 500 saw a loss of more than 16% in the same period, which is technically a correction.

The central bank paused, then reduced interest rates three times in 2019. Powell and the other participants didn’t want to harm the economy, which had finally recovered from the financial crisis.

And unsurprisingly, by the end of 2019, the S&P 500 regained its pre-correction level.

But don’t expect the market to have a similar one-eighty Fed reversal in 2019.

This is why: The economy remains robust. And compared to three years ago, inflation is far higher—and stickier.

Economists anticipate a slowdown in growth: According to FactSet, the real gross domestic product is predicted to grow by slightly over 1% this year and by just under 1% in 2023. The less-than-expected activity can halt the economy’s expansion or even turn the real GDP negative, narrowly triggering a recession.

Near that time, the Fed would likely cut down rate increases but not stop them altogether during the next few months, as it did in 2019.

A meaningful shift will likely only occur if the economy collapses, which almost certainly requires a worldwide financial crisis. The panic spread last week in the U.K. serves as just one illustration.

After the new prime minister’s drive to cut taxes by borrowing billions put rates through the roof, the Bank of England was forced to purchase bonds to support stocks and bonds. The BOE controlled the market. Averted, at least temporarily.

Eric Winograd, the senior economist at Alliance Bernstein, told Barron’s that only a contagion effect would make international events force the Fed to change course. “There must be proof that it has affected the financial system in the United States, and that seems exceedingly doubtful.”

In agreement with this statement is Wells Fargo’s senior U.S. equities strategist Christopher Harvey: “[The] highest chance for a Fed pivot if something truly catastrophic has happened and we have a market dislocation.”

Then, to confirm a Fed reversal, we return to a great decline in inflation. Of course, a course change can only occur if the economy remains robust, inflation declines, and corporate profits continue steadily.

The stock market would be happy. The S&P 500 would soar from below 3,800 to above 3900 before resuming its ascent toward its all-time high of 4796, attained in the first few days of January.

But it’s unlikely that will happen. Instead of decreasing, the inflation rate is edging down. And when it comes to his intention to lower costs, Powell has never held back.

Consequently, the stock market requires a dose of realism. Although the current state of affairs is worrying, the Fed isn’t stepping in to help.

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