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HomeMarketStocks Could Rally More If the Fed Pauses Rate Hikes

Stocks Could Rally More If the Fed Pauses Rate Hikes

U.S. Federal Reserve Bank Board Chairman Jerome Powell.

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Chip Somodevilla/Getty Images

The stock market has rallied as of late, anticipating a “Fed pause.” If that comes to fruition, the market is likely to surge even more. 

A Fed pause is when the Federal Reserve stops lifting interest rates. It does so either when the rate of inflation is aggressively declining or, regardless of inflation, it prefers not to put the economy into a deep recession. Rate hikes are designed to lower economic demand in order to reduce the extent of price increases for goods and services. Recently, the year-over-year gain in the Consumer Price Index has fallen to 7.7% in October from just over 9% in June. 

That’s why the stock market has rallied on the hope that the Fed is indeed close to pausing its rate hikes. The
S&P 500
is up about 11% from its lowest close of the year on Oct. 12, as Wall Street hopes the Fed slows down the pace of rate hikes. Markets now expect a rate increase of half a percent in December, rather than the three quarters of a percent seen in previous meetings. The Fed’s most recent minutes even revealed that members are cognizant that higher rates usually impact demand and inflation with a delay, so inflation could truly be on a path toward the central bank’s 2% target. Markets hope that, in 2023, the Fed pauses rate hikes altogether. 

When the Fed does pause, it usually adds even more juice to the stock market. On average historically, the S&P 500 sees a 14% gain during a pause, according to Morgan Stanley data. The duration of a pause is defined as when the Fed stops hiking to when it eventually cuts rates. The index posted a gain in five of the six instances the investment bank observed. The largest gain was 33%. The sole loss of 12% came during the recession that started in 2000, so it’s no surprise that the market was responding to the economic and earnings damage that caused the Fed to pause in the first place. 

That’s the next question: how deep would an impending recession be? If the U.S. only sees a mild recession, and the Fed pauses—or even cuts rates—a new bull market may have already started forming. If the already-higher rates are about to dent demand severely, and a brewing recession deepens, the market could eventually lose steam and see another decline.

The takeaway for now: if the Fed pauses its rate-hiking campaign soon, the most likely scenario is that the stock market performs well. 

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

Credit: marketwatch.com

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