A year after the Federal Reserve kicked off its most aggressive interest-rate hiking cycle in decades, the US stock market is at a pivotal stage, with jittery investors needing soothing more than ever.
The S&P 500 Index tumbled more than 4% last week, the most since September, after the collapse of high-profile Silicon Valley lender SVB Financial Group sparked fears of additional risks hiding on other banks’ balance sheets. Meanwhile, questions are swirling around the Fed’s policy path as the central bank enters its quiet period before its March 22 rate decision.
With Fed officials silent, all eyes are on Tuesday’s release of the consumer price index, after last week’s jobs data signaled inflation may be cooling. It sets the stage for a make-or-break stretch for stocks leading up to the central bank’s announcement and Chair Jerome Powell’s subsequent discussion of the path forward.
“There’s heightened sensitivity among investors to the CPI data, especially given what’s happening in the banking sector and concerns that the Fed’s interest-rate cycle is starting to have rippling effects throughout the economy,” said Yung-Yu Ma, chief investment strategist at BMO Wealth Management. “This is somewhat of a fragile time for equities.”
The CPI report is expected to give further evidence of ebbing inflation pressures, with forecasts calling for an annual growth rate of 6% in February, down from 6.4% in January. Should that be the case, it could strengthen reemerging bets in the swaps market that the Fed will end its tightening campaign around mid-year and cut rates by year-end, laying the foundation for an equities rebound in the second half of 2023.
It’s been a brutal year for stocks since the Fed began its tightening campaign on March 16, 2022. Rising rates dented the allure of technology and growth shares for most of last year, with the Nasdaq 100 Index plunging 33% in its largest drop since 2008. The S&P 500 also posted its biggest annual decline since the global financial crisis, tumbling 19%.
Stocks rallied to start 2023, but have since come back down, with the S&P 500 essentially flat for the year. So this week’s economic figures carry plenty of risk. Any sign that inflation is still stubbornly elevated may reignite bets on a more hawkish Fed, putting pressure on expensive corners of the stock market, such as technology.
At the end of last week, swaps traders downshifted wagers on the Fed’s peak rate to roughly 5.3% at midyear from as high as 5.7% in September just days earlier. That shift fueled the biggest tumble in two-year Treasury yields since 2008. Traders are also now favoring a quarter-point Fed increase this month instead of a half, from its current range of 4.5%-4.75%.
In addition, near-term anxiety is on full display in stocks. A gauge of projected S&P 500 turbulence over the next two weeks — which includes updates on CPI and producer prices, the Fed decision and S&P Global services PMI data — is hovering near 25, some 3.2 points above the expected volatility two months from now. That’s the widest gap since October.
“The jobs data together with the inflation print and the Fed’s rate decision will give investors a good sense of how the Fed’s path to price stability is going to look,” said Quincy Krosby, chief global strategist at LPL Financial.
The key issue facing Wall Street is how close the Fed is to ending its rate increases — a juncture that historically has delivered double-digit returns for equities.
The past eight hiking cycles saw the Fed continue to lift its benchmark until it was above CPI, according to Carson Investment Research. That means there still could be more room for the Fed to lift rates to tame high prices.
“This is a very nervous market, but the Fed’s medicine is working,” said Eric Diton, president and managing director of The Wealth Alliance. It takes one to two years for rate hikes to filter “through the economy so the next few months will probably be bumpy for stock investors.”