The Fed is still not a friend of the stock market

It has been a difficult year for the stock market so far, despite Wednesday’s rally. Unfortunately for investors, the Federal Reserve probably does not feel their pain. Nor is it likely to happen soon.

Fed policymakers on Wednesday raised their overnight interest rate target range by half a percentage point — more than a quarter increase in their initial tightening effort in March — and made it clear that interest rate hikes would continue. to come. They also announced that the Fed would begin reducing its $ 9 trillion asset portfolio, leaving $ 47.5 billion in government bonds and mortgages for each of the three months beginning in June, raising it to $ 95 billion. September.

Shares rose sharply after Fed Chairman Jerome Powell said the central bank was not “actively considering” raising interest rates by three-quarters of a percentage point. However, the Fed survey over the past few months has made a strong punch, one or two punches: The Fed aims to slow the economy, which usually leads to slower earnings growth as well – and sometimes even profits. in full contraction. Second, higher interest rates increase the relative attractiveness of fixed income products to equities. The S&P 500 has fallen about 10% so far this year, and the tighter the Fed, the tougher the stock environment could be.

Certainly, if the stock market were falling very, very fast, the Fed would probably be waiting for its plans to tighten. Serious hardship in the financial markets would be too risky for the economy for the central bank to ignore. But it would probably take a much stronger selloff to do so than, say, the 20% drop in the S&P 500 by the end of 2018 that helped the Fed keep its hand on interest rate hikes.

One big difference is that after years of worrying that inflation was too low, it is now definitely too high. While both the Fed and most economists believe inflation will subside in the coming months, they still believe the year will end above the central bank’s 2% target. In addition, with rising wage pressure, the Fed aims to cool the job market, something it was reluctant to do in late 2018, when wage growth was modest.

And there are reasons why the Fed may believe it can safely ignore the stock fall. First, even with recent reductions, valuations seem steep in relation to history. Therefore, further reductions could simply be seen as air outflows from an expensive market, rather than a reflection of financial problems.

Second, and perhaps most importantly, declining stocks may not cause many financial problems. Household balance sheets are in good shape, with debt-to-income levels significantly lower than they were in the period before the 2008-09 financial crisis. Corporate balance sheets look strong, in part because many companies took advantage of lower interest rates during the pandemic to lock in lower borrowing costs. In addition, companies’ need for employees is so strong – the Ministry of Labor recently reported that there were 1.9 jobs for every unemployed employee in March – that falling stock prices alone may not prevent them from hiring soon. employees.

The Fed will not stop trying to cool the economy until the economy cools. Until then there could be more pain for stocks.

I write to you Justin Lahart at

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The Fed is still not a friend of the stock market

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