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Can the Fed tame inflation without further crushing the stock market? What’s next for investors?

The Federal Reserve isn’t trying to hammer the stock market as it quickly raises interest rates in its bid to curb inflation that remains red-hot — but investors need to be prepared for more pain and volatility because policymakers aren’t going to be cowed by a deeper selloff, investors said and strategists.

“I don’t think they’re necessarily trying to drive inflation down by destroying stock prices or bond prices, but it does have that effect.” Tim Courtney, chief investment officer at Exencial Wealth Advisors, said in an interview.

US stocks fell sharply in the past week after hopes of a marked cooling in inflation were dashed by a warmer-than-expected inflation reading in August. The data cemented expectations among Fed funds futures traders for a rate hike of at least 75 basis points when the Fed concludes its policy meeting on September 21[ads1], with some traders and analysts looking for a 100 basis point increase, or a full percentage point. point.

Preview: The Fed is ready to tell us how much “pain” the economy will suffer. It will not, however, indicate a recession.

Dow Jones Industrial Average DJIA,
recorded a weekly drop of 4.1%, while the S&P 500 SPX,
fell 4.8% and the Nasdaq Composite COMP,
had a decrease of 5.5 percent. The S&P 500 ended Friday below the 3,900 level seen as a key area of ​​technical support, with some chart watchers eyeing the potential for a 2022 test of the large-cap benchmark at 3,666.77 set on June 16.

See: Stock bears hold the upper hand when the S&P 500 falls below 3,900

A profit warning from global shipping giant and economic bellwether FedEx Corp. FDX,
further increased fears of recession, contributing to losses in the stock market on Friday.

Read: Why FedEx’s stock plunge is so bad for the entire stock market

Treasurys also fell, with yields on the 2-year Treasury note TMUBMUSD02Y,
shoot to a near 15-year high above 3.85% on expectations that the Fed will continue to push interest rates higher in the coming months. The yield rises when prices fall.

Investors operate in an environment where the central bank’s need to rein in stubborn inflation is widely seen as having eliminated the notion of a figurative “Fed put” in the stock market.

The concept of a Fed put has been around since at least the October 1987 stock market crash prompted the Alan Greenspan-led central bank to cut interest rates. An actual put option is a financial derivative that gives the holder the right, but not the obligation, to sell the underlying asset at a set level, known as the strike price, and acts as insurance against market downturns.

Some economists and analysts have even suggested that the Fed should welcome or even target market losses, which could serve to tighten financial conditions as investors scale back spending.

Related: Do higher stock prices make it harder for the Fed to fight inflation? The short answer is “yes”

William Dudley, the former president of the New York Fed, argued earlier this year that the central bank will not tackle inflation approaching 40-year highs unless they make investors suffer. “It’s hard to know how much the Federal Reserve will need to do to get inflation under control,” Dudley wrote in a Bloomberg column in April. “But one thing is certain: to be effective, it will have to inflict more losses on stock and bond investors than it has so far.”

Some market participants are not convinced. Aoifinn Devitt, investment manager at Moneta, said the Fed likely sees stock market volatility as a byproduct of its efforts to tighten monetary policy, not a goal.

“They recognize that stocks can be the casualty of a tightening cycle,” but that doesn’t mean stocks “need to collapse,” Devitt said.

However, the Fed is prepared to tolerate seeing markets fall and the economy slowly and even tip into recession as it focuses on taming inflation, she said.

Recently: Fed’s Powell says bringing down inflation will cause pain for households and businesses in Jackson Hole speech

The Federal Reserve kept the target fed funds rate in a range of 0% to 0.25% between 2008 and 2015 as it dealt with the financial crisis and its aftermath. The Fed also cut interest rates to near zero again in March 2020 in response to the COVID-19 pandemic. With a bottom rate, the Dow DJIA,
skyrocketed over 40%, while the large-cap index S&P 500 SPX,
jumped more than 60% between March 2020 and December 2021, according to Dow Jones Market Data.

Investors were getting used to the “tailwinds of over a decade of falling interest rates” as they looked for the Fed to step in with its “put” if the going got tough, said Courtney of Exencial Wealth Advisors.

“I think (now) the Fed message is ‘you’re not going to get this tailwind anymore,'” Courtney told MarketWatch on Thursday. “I think markets can grow, but they have to grow on their own because markets are like a greenhouse where the temperatures have to be kept at a certain level all day and all night, and I think that’s the message that markets can and should grow on their own without the greenhouse effect. »

See: Opinion: The stock market trend is relentlessly bearish, especially after this week’s big daily drop

Meanwhile, the Fed’s aggressive stance means investors should be prepared for what could be “a few more daily stabs to the downside” that could ultimately turn out to be a “final big flush,” Liz Young, head of investment strategy at SoFi, said on a Thursday. Note.

“This may sound strange, but if it happens quickly, meaning in the next couple of months, it will actually be the bull case in my view,” she said. “It could be a quick and painful fall, resulting in a renewed move higher later in the year that is more durable, as inflation falls more noticeably.”

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