It’s dawning on stock investors that they were wrong about the Federal Reserve.
After rallying behind a resilient economy, slowing inflation and the hope that the central bank would end its interest-rate increases sooner than it had communicated, stock trading has grown jittery.
The S&P 500 lost its momentum in February, after a drop this week that left it 2.4% lower than its peak early in the month.
Stocks have oscillated between gains and losses as new economic data has clouded the outlook for investors, marking a notable shift in the market after stocks jumped more than 6% in January.
The change in tone this week came as a steady flow of data has shown the economy continued to run hot in January. Despite high-profile layoffs at big technology firms like Meta and Microsoft, employers in the United States continued to hire at a rapid clip, consumers kept spending, and prices continued to rise briskly at the start of the year across an array of goods and services.
All those data points suggest that the economy retains significant vigour, even after a year of rapid policy adjustments aimed at cooling down the economy.
Fed officials had repeatedly warned that there was more work to do to slow rising prices, but investors had hoped that a slowdown in inflation that took hold in earnest late last year would allow policymakers to hit pause on their rate adjustments sooner than they had predicted.
Now, mounting evidence that the economy remains surprisingly strong and price increases unexpectedly stubborn have begun undercutting that narrative.
In response, investors have sharply raised their expectations for the number of times the Fed will increase interest rates in the coming months. And even central bankers have begun to float the possibility that rates will need to climb higher than they previously expected if the economy does not cool down.
Higher interest rates raise costs for consumers and companies, slowing demand and typically weighing on the stock market.
“I’m very negative right now on equities,” said Eric Johnston, the head of equity derivatives at Cantor Fitzgerald, who predicted the recent S&P 500 rally but now expects a slump.
“I think the move we have seen in the rate market, some of the inflation numbers that have come out and the expectation that the economy will be fine is all fairly problematic.”
Johnston now thinks the S&P 500 will eventually fall below its 2022 low, a drop of more than 10% from current levels. Strategists at Morgan Stanley and JPMorgan Chase are also among those bracing for a fall.
Bond investors had been quicker to shift their view.
At the start of this month, investors betting on the path of interest rates predicted the Fed would raise its benchmark rate just once more this year, by a quarter of a percentage point in March.
Now, those traders are leaning to three increases of that size, through July, which would take the Fed’s target rate to a range of 5.25% to 5.5%. That’s above the Fed’s own most recent forecasts, published in December.
But policymakers have also hinted that their own estimates could be poised for revision if the economy continues to run hotter than previously anticipated.
John C. Williams, president of the powerful Federal Reserve Bank of New York, suggested this week that rates were likely to rise to a range of 5% to 5.5% — slightly above the 5% to 5.25% median in the central bank’s December forecast.
He and several of his colleagues have said they may need to do even more than that if consumption and the labour market remain so robust.
“With the strength in the labour market, clearly there’s risks that inflation stays higher for longer than expected or that we might need to raise rates higher than that,” Williams told reporters in New York this week.
Loretta Mester, the president of the Federal Reserve Bank of Cleveland, said during a speech Thursday that “we may very well have to move higher, hold it longer at that peak rate or even change what we do at any particular meeting” if economic pressures kept inflation elevated.
Given recent data, economists at Goldman Sachs and Bank of America changed their forecasts.
They are now predicting that the Fed would raise rates to 5.25% to 5.5% this year — a quarter point higher than either bank had previously estimated.
— The New York Times
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