A Fed Pause Is Coming. Stocks May Not Rally When It Arrives.

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Federal Reserve Board Chairman Jerome Powell. Getty Images)


Olivier Douliery/AFP via Getty Images

The long-anticipated pause in the Federal Reserve’s interest-rate increases is almost here. The actual news isn’t likely to bring about a surge in stock prices. 

The central bank is making progress in its effort to rein in inflation by raising rates to reduce demand for goods and services. Policy makers want inflation to keep falling, but they don’t want to hurt the economy too badly, and it isn’t clear how much damage is still to come from the nine rates increases they have rolled out over the past year.

The upshot is that the rate increases could be over starting this June. The federal funds futures market is pricing in a roughly 70% chance that the Fed won’t hike the benchmark lending rate then, according to CME Group data. The minutes from the Federal Open Market Committee’s March meeting show that members considered pausing last month. Futures even reflect a 10% chance that the committee cuts rates in June.

Investors have been hoping the Fed will hit the pause button since last year, but share prices already seem to have factored it in.

The
S&P 500
is up about 16% since hitting the low point of its bear market in early October. Treasury yields, which have been rising and falling in line with expectations about the fed-funds rate, have dropped. Those gains in stocks signal relief that the rate hikes haven’t derailed the economy, plus expectations that growth will eventually stabilize and rebound, with positive effects on corporate earnings.

That means a halt to increases, and a drop in borrowing costs, may not spur much more of a stock-market gain. 

Now, the stock market’s focus on economic data may shift. While investors once hoped for indications that the economy was weakening, seeing that as a sign that the Fed might stop raising rates, they now might look for data showing strength as evidence that demand is holding up better than currently expected.

Stocks may now turn lower if the data indicate that the Fed’s tighter policy is pushing the U.S. into a recession, which would pressure companies’ profits. As demand and inflation take a hit in the immediate term, rates in the bond market should fall as well, which means that lower rates may now mean poor stock-market performance.

“In 2023 a pause, given that there are rate cuts priced for July is likely a ‘sell the news’ event,” wrote Evercore strategist Julian Emanuel. 

There is, however, a caveat to all of this. The market tends to rise in the year after a Fed pause, with a historical average gain of 12% in the S&P 500, according to Evercore. That could still happen this time, but with some initial volatility, or even a quick decline.  

Buying stocks isn’t a bad idea, but this moment may not be the best time to do so aggressively. 

Write to Jacob Sonenshine at [email protected]

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