Stock Surged After Fed Says Interest Rate Hikes Could Slow — but Investors Shouldn’t Celebrate Too Early
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Jerome Powell gave investors some much-needed holiday cheer on Wednesday.
At a speech at the Brookings Institution, the chair of the Federal Reserve signaled that smaller interest rate hikes could come as soon as this month.
The central bank has spent the year in a battle with decades-high inflation. In order to bring down spiraling consumer prices, it's been raising interest rates at an aggressive pace. Most recently, the Fed hiked its benchmark interest rate by 0.75% in November, bringing the Fed’s benchmark federal funds rate to a target range of between 3.75% and 4%. It was the sixth hike in the span of a year and the fourth consecutive hike that large.
But now, it looks like those big hikes may be behind us.
"Monetary policy affects the economy and inflation with uncertain lags, and the full effects of our rapid tightening so far are yet to be felt," Powell said. "Thus, it makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down."
He added that moderating the pace of rate increases could come as soon as the next Federal Open Market Committee (FOMC) meeting, which is scheduled for Dec. 13-14.
Stocks surged after Powell's comments on Wednesday, with the S&P 500 ending the day up 3.1% and the Nasdaq Composite up 4.4%.
Why investors are hopeful stocks will rise
Interest rate hikes are a tool the Fed uses to bring down inflation, but those increases can also weigh on the prices of financial assets, like stocks. That's because higher rates make it more expensive for financial institutions to borrow money, and a ripple effect ends up increasing the borrowing costs for companies and consumers. Businesses face higher costs and consumers have less money to spend. This hurts how much companies earn and how those companies are expected to perform moving forward. And that can cause their stock prices to fall.
Stocks, along with other assets like bonds and crypto, have certainly struggled this year. The S&P 500 is down around 15% for the year.
So the notion that interest rate hikes could soon be smaller was welcome news for investors.
Why investors shouldn't get too excited
To be clear, this doesn't mean interest rate hikes are going away. In fact, Powell explicitly said they're not: "We anticipate that ongoing increases will be appropriate," he said.
Powell pointed out that while bottlenecks in goods production and the price of goods appear to be easing, the labor market "shows only tentative signs of rebalancing" and wage growth is still "well above levels that would be consistent with 2% inflation over time." (The FOMC targets a 2% inflation rate.)
"Despite some promising developments, we have a long way to go in restoring price stability," he added. Doing so may mean holding policy "at a restrictive level for some time."
As in, while interest rate hikes may get smaller, investors probably shouldn't expect a complete turnaround anytime soon.
"Before you get too excited, remember that this is a shift, not a pivot," Callie Cox, an analyst at the investment firm eToro, said in a note shared with Money. "Powell has been clear that rates could stay high for some time."
She added that "a high-rate environment isn’t the easiest to invest in, and we could be in for a tougher slog to the highs until inflation comes down significantly."
Strategists at JPMorgan Chase & Co. said in a note Thursday that U.S. stocks could decline sharply in the first half of 2023 before rebounding. Mark Haefele, chief investment officer at UBS Global Wealth Management, said in a research note that, "Despite the recent rebound in equities, we do not think the macroeconomic conditions for a sustained market rally are yet in place."
So for now, investors shouldn't get too ahead of themselves.
"History cautions strongly against prematurely loosening policy," Powell concluded. "We will stay the course until the job is done."
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