The Federal Reserve rate hike that will be announced this afternoon could turn out to be the last of the cycle. But chair Jerome Powell will likely try his best to convince Wall Street that the Fed isn't done in a bid to keep the AI-fueled S&P 500 rally from getting out of hand.
Markets have fully priced in a quarter-point hike on Wednesday, lifting the federal funds rate to a range of 5.25% to 5.5%, the highest since March 2001. But investors aren't buying the Fed's guidance for one additional quarter-point hike this fall.
The Fed's Final Hike?
As it stands, markets see just 21% odds of a Fed rate hike to a range of 5.5% to 5.75% at the next policy update on Sept. 20, rising to 37% odds of a hike on Nov. 1.
To be sure, Wall Street has pretty good reason to think the Fed may be done after Wednesday. The consumer is slowing as pandemic savings dwindle, and that's even before student loan repayments are set to resume in October. Meanwhile, the June consumer price index showed core inflation falling to 4.8% from 5.3% in May, and further progress is expected in coming months. Given the time lag between interest-rate hikes and their impact on the economy, Federal Reserve policymakers can be pretty sure that further slowing is in the pipeline.
Inflation Risk: Still Tilted To The Upside?
Yet Powell has been saying for much of the past year that the Fed should err on the side of doing too much to combat inflation, rather than too little, because elevated inflation is harder to uproot once it becomes entrenched. The same argument applies to Fed communications.
In his June 14 news conference, following a decision to skip a rate hike, Powell indicated that Fed committee members still thought "the risks to inflation are to the upside."
Despite tamer June inflation data, Powell will likely sing the same tune on Wednesday. Otherwise, Treasury yields could fall and the S&P 500 could rise, supporting economic activity with lower borrowing costs and higher asset prices.
Is Next Fed Meeting A 'Live' One?
The Federal Reserve decision to skip a rate hike in June before hiking again in July raises another key question Powell is likely to face. Has the Fed slowed to an every-other-meeting pace? Or, as Powell said about July's meeting back in June, will September's meeting be a "live" one, with a rate hike up for debate? This might be the answer that markets react to most.
It's a good bet that Powell will give September's meeting the "live" designation. That's partly because the nearly two-month break between the July and September meetings is the longest of the year, so there will be a lot more data to evaluate.
Powell's pushback against a hint of complacency on Wall Street that the inflation battle is nearly won could lead to a bit of selling pressure for the S&P 500. However, incoming economic data, which will ultimately determine the Fed's next move, will probably have a bigger impact on Treasury yields and stock prices.
Some key data releases will come right on the heels of today's Federal Reserve meeting. Second-quarter GDP, out Thursday, is expected to show the economy slowed to 1.5% growth, down from 2% in Q1. On Friday, the Fed's primary inflation indicator, the PCE price index, is expected to show core prices rising a tame 0.2%. That would lower the core PCE inflation rate to 4.2% from 4.6%.
Also Friday, at 8:30 a.m., the Employment Cost Index, the Fed's favorite wage-growth tracker, is expected to show compensation rose 1.1% in Q2. While progress from 1.2% growth in Q1, that would still be too hot for the Fed.
S&P 500
The S&P 500 rose 0.3% to 4567 in Tuesday's stock market action, finishing at a 15-month closing high. That puts the S&P 500 27.7% above its Oct. 12 bear-market closing low and just 4.8% off its all-time closing high on Jan. 3, 2022. The Nasdaq has been even hotter, surging 35.1% year to date vs. the 19% S&P 500 gain.
Deutsche Bank economist Matthew Luzzetti noted potential for "Powell skewing somewhat more hawkish given easing financial conditions" reflected in higher stock prices.
Still, markets face "limited downside" from Fed signaling, he wrote. That's because there are two monthly jobs reports and CPI reports ahead of the next Fed meeting, and economists are expecting those to come in on the soft side.
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