Investors in both the stock and bond markets are facing an important decision on Wednesday when the Federal Reserve announces its interest-rate decision. “The answer to the question ‘How long will rates stay high?’ will now determine if a Fed comment or decision is either hawkish (bad for stocks/bonds) or dovish (good for stocks/bonds),” according to Tom Essaye, founder of Sevens Report Research.
This is a shift from the previous scenario that has been observed during Fed meetings since last year when interest rates started to rise. The Fed is now believed to be near the end of its rate increases. While the central bank is most likely to leave rates unchanged on Wednesday, market participants will be closely watching the dot plot, which represents individual policy makers’ expectations for future interest rates, for clues about the timing and extent of future rate cuts.
Kit Juckes, global macro strategist at Société Générale, says that the market expects the dot plot to show a rate hike and then a steady fall, but there is a possibility that rate cuts will be pushed further into the future. The statement from the Federal Open Market Committee (FOMC) is expected to have a hawkish tone, reinforcing the message that rates will remain high for a longer period of time.
According to Essaye, the assumption that the Fed is nearing the end of its rate-hike cycle has been a key driver of the stock market rally in 2023. However, any indication in the Fed’s policy statement or remarks by Fed Chair Jerome Powell that contradicts these assumptions could lead to market weakness. In fact, Essaye warns that if the market has to digest the news that the Fed will keep rates high for a longer period of time, it could potentially trigger a 5% or even a 10% pullback in the stock market.
On the other hand, if the Fed leaves rates unchanged and doesn’t alter its language or the median dot for 2024 remains at 4.625%, the market is unlikely to react significantly, according to Essaye. A hike in rates or an increase in the 2024 dot to 4.875% would likely unsettle stocks and result in a steep decline in the market.
So what could trigger gains in the stock market? If the June projections show a median 2023 dot of 5.625% but the dot on Wednesday falls back to 5.375%, it would signal that policy makers believe they are done with rate hikes and could potentially lead to a solid rally in the market.
On Tuesday, the stock market was under pressure as the Fed’s two-day policy meeting began, with the Dow Jones Industrial Average down around 170 points, or 0.5%, the S&P 500 down 0.4%, and the Nasdaq Composite down 0.3%.