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How will stocks react to this week’s Fed announcement?

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How will stocks react to this week’s Fed announcement?

OOver the past few weeks, as the stock market bounced back from its Oct. 13 lows, traders and investors have seemingly been focused on several data points related to the economy and the market. GDP, inflation and income numbers have all moved the needle, but no matter how much we may tell ourselves that these things matter, everything is now filtered through the big daddy of all influences: the Fed. We’ll hear them this week. The market is confident that they know what the Fed is going to do at this meeting, that they will raise rates by another three-quarters of one percent, but they are waiting to see what the Fed will say after this meeting. Will there be a hint of a pause or a commitment to “consistency” that suggests they will continue to raise rates until real damage is done?

At times like this, when speculation runs rampant, the forward-looking nature of the market can lead to such swings based on very little volume that it can look ridiculous when taken out of context. For example, a drop in the 3-month moving average growth rate of core PCE could lead to a strong rally even though inflation is still at its highest level since the 1980s. Similarly, GDP growth of 2.5% looks strong after two consecutive quarters of negative impressions, but could still cause stocks to wobble. In both cases, the data itself is not the driving force; it’s how readers and investors think the numbers will affect the Fed.

Fed Chairman Jerome Powell said that as the main indicator of inflation in the economy, the Fed sticks to the average core PCE, an inflation measure that takes into account how consumers change their buying patterns as well as their overall spending in response to rising prices. However, he also said they are aware of the danger of overdoing it and dragging the economy into an unnecessary recession. Therefore, a decline in core PCE growth could lead to a significant rally because it signals that the Fed is keeping inflation under control and may change course soon. Meanwhile, a decent GDP number is seen as an indicator of the economy’s resilience and thus likely delaying any policy pause or reversal and could cause stocks to fall unwisely.

However, we have reached a point where muddled thinking has gone too far. Yes, even a small trend change in core PCE could be positive, and strong GDP numbers could delay the unwinding of policy, but taken together, they show that despite a series of aggressive Fed rate hikes that have started to dampen inflation, the US economy grew in the third quarter . In other words, we are in a good place.

This leaves unanswered an important question: Will the delicate balance that the data suggest lead to overconfidence? Will the FOMC take too long to go too far, repeating the mistake that got us into this mess, only in reverse?

History suggests that it will. The resilience of the American economy has been one of its greatest features for decades, and it is what has allowed it to withstand intervention by the Fed for the past fifty years or so. Of course, the central bank has a duty to intervene during a crisis, but it has always been reluctant to move to a neutral position when the data starts to show that it is achieving its goals. However, this time there is hope. Jay Powell at least said he was aware of the risks, which is a good start.

There’s a good chance it will do so again, even if the committee raises rates by another 75 basis points this week, severely limiting downside risk for stocks. I suggest that there is a small chance that the FOMC views the situation as one in which inflation continues and GDP recovers, and thus increases by a whole point, but it is highly unlikely. However, it is easy to see them rising by the expected amount and hinting at a moment when they will pause to assess the impact of “normalized” interest rates.

What all this means for the markets this week is that it suggests an opportunity. Traders know the history of the Fed and don’t have much faith in Powell right now, so they are likely to start the week in a cautious mood and stocks will be lower over the next few days. However, it’s hard to see how he could screw it up given that the data is on his side. ​​​​​​While the initial reaction to the announcement may be negative, the selling is likely to turn out to be a consolidation move that will lead to higher gains later this month.

The views and opinions expressed herein are those of the author and do not necessarily reflect those of Nasdaq, Inc.

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