The stock market has acted as if the Federal Reserve doesn’t exist as it jumps out to a quick start to the year. Expect Fed Chairman Jerome Powell to remind it when the central bank hikes interest rates this coming week.
Dow Jones Industrial Average
gained 1.8% this past week, while the
advanced 2.5% and the
rose 4.3%. It was the S&P’s third gain in four weeks, putting the index up almost 14% from its bear-market low in early October.
There’s no big secret about what’s driving that rally. Inflation has been falling, and the market is betting that the Fed will see enough improvement to stop hiking interest rates in the near future. That would be good news, of course, because investors’ big fear is that the central bank will tighten right into a recession.
It’s all very encouraging, but there’s a Fed announcement coming Wednesday, and there’s a good chance the central bank will feel the need to push back against the bulls’ expectations. It won’t be with the Federal Open Market Committee’s rate hike; there’s a near certainty of a quarter-point increase in the federal-funds rate.
But inflation, whether reflected in the consumer price index or the personal-consumption expenditures deflator, or PCE, is still higher than the Fed’s target of 2%. And the central bank can’t be happy with the easing of financial conditions that occurs anytime the stock market rallies. Expect the chairman to have something to say about that.
“Powell will likely emphasize that rates will stay elevated for some time…despite the softer inflation data,” writes Citigroup economist Andrew Hollenhorst.
The Fed’s wish to tighten conditions could stop, at least temporarily, the stock market rally that has seen the Nasdaq gain 11% this month, its best January since 2001. The gains have left the S&P 500 looking expensive at 17.9 times earnings, up from 16.7 at the end of 2022, even as companies such as
(ticker: MSFT) and
(TXN) continue to guide earnings lower. “Rich valuations point to some meaningful downside,” writes Benson Durham, Piper Sandler’s head of global asset allocation.
Valuations aside, the S&P 500 is now at a level it has had trouble surpassing. While it has breached its 200-day moving average in recent days, the index is still just under 4100, a level at which sellers have come in to knock it down several times.
Even if the Fed sounds moderately hawkish, the index could inch its way to that level, says John Kolovos, chief technical strategist at Macro Risk Advisors, but a more substantial rally is unlikely without more conclusive proof that the economy is heading for a soft landing.
Ultimately, that’s not a great setup for the market in advance of the FOMC meeting. “The risk/reward doesn’t seem great, heading into Fed day,” says Chris Harvey, chief U.S. equity strategist at Wells Fargo Securities. “Powell will have a continued focus on tighter for longer, and that’s not what the market wants to hear.”
Not that it’s been listening.
Write to Jacob Sonenshine at email@example.com