Fed and Wall Street ‘in a fight’ over inflation cure

The Federal Reserve and the stock market are at odds over the central bank’s efforts to combat inflation.

Stocks capped a sharp two-day selloff on Friday, wiping out gains from a rally earlier in the week fueled by hopeful economic news. Inflation, as measured by the consumer price index, had fallen for the fifth month in a row, and much more than analysts had expected, according to data released just before the Fed moved to rein in its interest rate hikes.

While the Fed ended up raising rates by less than its previous four hikes, a dour forecast from officials including Chairman Jerome Powell shook markets out of their optimism. Instead of signs of lower interest rates ahead, the Fed warned that rates would be even higher and stay that way for longer.

The Dow Jones industrial average closed down 281 points on Friday, falling 0.9 percent on the day for the second straight week of losses. The S&P 500 Index closed down 1.1 percent and the Nasdaq closed down 1 percent on the day, respectively.

“The Fed and the stock market are fighting. They are in a fight right now,” Callie Cox, a US investment analyst at online investment firm eToro, said in a phone interview on Friday.

“The stock market has been itching for a turnaround for months, actually since the summer, and the Federal Reserve has told us over and over again that they are serious about inflation, that they want to control it, and if that means holding rates high for a while, so be it,” he added.

As interest rates continue to rise, companies will face higher borrowing costs and have less money to invest in expansion, making their shares less attractive to investors. Households will also have less income to spend in the market as interest rates on their mortgages, car payments and credit cards rise.

Still, stock market difficulties are a big part of the Fed’s plan.

Fed officials know that their tough talk about keeping rates high and eliminating inflation at any cost alarms investors and traders. Those warnings are meant to keep Americans’ expectations in check and force companies to feel the pressure of high rates without stock prices rising to cushion the blow.

“The Fed knows that its words are just as powerful in a world where social media is so ubiquitous and information moves so fast,” Cox said. “The Fed is preparing the markets for what is coming before it actually happens. This time, however, it feels a little more painful because the Fed needs to bring inflation down.”

Powell said during a news conference on Wednesday that the United States still had “a long way to go” before inflation dropped to a sustainable level. He added that the only way the Fed would achieve that goal was to keep its foot on the brakes on the economy with high interest rates aimed at boosting the unemployment rate.

November’s unemployment rate of 3.7 percent is just 0.2 percentage point below its level in February 2020, then a five-decade record low. But the US workforce is about 4 million fewer workers now than it was before the start of the pandemic, while businesses post record numbers of job openings.

With fewer workers available to fill open positions, companies have been forced to raise wages to attract candidates and prices to offset that higher wage. That dynamic, say Fed officials, is why inflation has remained high even as the prices of almost all goods except food have fallen.

“We have too many jobs and too few workers, which means wage inflation will be far from a sustainable average, and that will feed through to prices. That’s what we’re working on right now,” Mary Daly, president of the San Francisco Federal Reserve, said in a statement. a Friday event hosted by the American Enterprise Institute.

“To be honest with you, I don’t really know why the markets are so bullish on inflation,” Daly said.

On Wednesday, Fed officials boosted their projections for how much they would need to raise interest rates and how long they would keep them at levels meant to hamper the job market.

They now expect to raise interest rates to a range of 5 to 5.25 percent by the end of 2023, up from the 4.5 to 4.75 range that officials projected in September, and do not expect to cut rates until 2024. .

The Fed also sees that its rate hikes will hit the US economy badly, projecting the unemployment rate to rise by 0.9 percentage points to 4.6 percent by the end of 2023 and economic growth to slow. at 0.5 percent. While Fed officials say large job losses can be avoided in that scenario, most outside economists believe that such a rise in the unemployment rate would mean more than 1 million Americans would lose their jobs.

“The Fed did not welcome the disinflation trends that have just begun to emerge and focused on strong job creation and elevated inflation. Any hope of a soft landing is gone as the Fed appears committed to raising rates much higher,” Edward Moya, senior market analyst at OANDA, said in a Wednesday note to clients.

A Federal Reserve-led recession or sharp slowdown would be more bad news for the stock market, as businesses struggle with lower sales and fewer households have the flexibility to invest money in risky assets. But higher rates themselves could be a bigger, longer-term shock absorber on the stock market.

Stocks exploded in value in the years after the Great Recession, as the Federal Reserve kept its benchmark interest rate range close to zero. The market’s impressive rally accelerated further during the COVID-19 pandemic, as low interest rates and trillions of dollars in federal stimulus helped drive new records across all three major indexes.

With rates likely to stay high for much longer, Cox said the days of the market hitting record highs again are likely a long way off.

“When we look at 2023, we see it as a year of purgatory,” he said.