Investors were hesitant on Wall Street. But, at the closing touch of this Wednesday, the sanction fell: the main US stock indices closed with sharp falls, from 1.7% for the Dow Jones to 1.79% for the Nasdaq, after the decision of the US central bank (Fed) to raise its reference rates by 75 basis points, that is, now within a range of between 3% and 3.25%. The Federal Reserve has not tightened its monetary policy so quickly since the 1980s under the presidency of the monetarist Paul Volker himself. The stock market is still headed in a bad direction on Thursday and the European indices are frankly in negative territory. In Paris, the CAC 40 is even slipping towards 5,900 points.
However, this 75 basis point increase is not a surprise: it was anticipated by more than 80% by the market, according to the FedWatch index. But strong rhetoric from Fed Chairman Jerome Powell left the door open for further hikes at the next two monetary policy committee meetings in November and December.
In fact, central bankers forecast an increase of at least 125 basis points, which would take the median key rate to 4.4% and the “terminal rate” -or peak- to 4.6% in 2023. And it is not so , we should not wait for him to cut rates before… 2024. The illusion, dashed for a moment after the previous 75 basis point hike in July, of a pause in monetary tightening, has completely dissipated.
Until the job is done
Jerome Powell’s comments are thus in line with those at Jackson Hole (where the Fed holds an annual conference with the banks): priority given to fighting inflation at the risk of causing a hard landing for the US economy, even a recession. The word is firm and it is no longer moving away from the objective of bringing inflation to around 2% (compared to 8.3% in August).
“Since Jackson Hole, the market has understood that the Fed will have to keep rates high for a while to have an effect on inflation that has become structural”a bond manager told us before Wednesday’s meeting. “We will continue until the work is finished”Jerome Powell said Wednesday, without elaborating on how long it will take to curb inflation.
All eyes are now on the US employment figures, which have become the barometer for testing the aggressiveness of the Fed’s monetary policy. Now one thing is certain: investors can no longer trust the central bank support, as they have been used to since the 2008 financial crisis.
It is this paradigm shift that is pushing markets, stocks and bonds down. After some denial, investors are returned – brutally – to the reality principle, that of a long period with high rates.
Rise leads to fall
That is why, this time, the September rate hike was not greeted, as before, by a rally in equities. In each previous rate hike in the US (March 16, May 4, June 15 and July 27), the S&P index had risen 0.56%, 2.2%, 3% and 2 .6%, respectively. Admittedly, these rallies quickly appeared to be short-lived, except perhaps in July, with the S&P index down 20% since the start of the year. Which qualifies the market as bearish.
“No one knows if the process (of raising rates, Editor’s Note) will lead to a recession or not”underlined Jerome Powell, for whom “It will depend on how quickly inflationary pressures on wages and prices subside.” Leaving little hope for a soft landing for the economy. And yet the stock market still believes in it!
In the meantime, the markets should continue their gentle decline, even if more and more voices on Wall Street believe that most of the decline has already occurred. The market needs time to digest this new environment, but the fall in valuations, both for equities and fixed income, may offer new buying opportunities.