With the Federal Open Market Committee kicking off its two-day policy meeting, where central bankers are expected to announce a 0.75 percentage point rate hike, the Fed decision on Wednesday may once again be followed by stock-market gains, according to DataTrek Research co-founder Nicholas Colas.
According to Dow Jones Market Data, the previous four times the Fed raised interest rates in 2022 — March 16, May 4, June 15 and July 27 — the S&P 500 SPX, -1.13% rallied 2.2%, 3%, 1.5% and 2.6%, respectively.
“Wednesdays of Fed meeting weeks this year show the highest daily S&P returns of 1.8 percent on average for the 5-day period, and the best win rate as well,” the Wall Street veteran wrote in a Tuesday note.
“No guarantees that this will happen again this Wednesday, of course, but we would not be surprised to see traders front-run this fact tomorrow,” Colas noted.
Those bounces have so far proved fleeting, with the S&P 500 mired in a bear market and down more than 19% for the year to date. Indeed, the Fed’s aggressive tightening pace as it attempts to rein in stubborn inflation gets much of the blame for the market’s 2022 downturn.
U.S. stocks started the week higher with the S&P 500 closing up by 0.7% on Monday. However, stocks came under pressure on Tuesday as investors held firm on expectation of another aggressive rate hike. The Dow Jones Industrial Average DJIA, -1.01% finished 313 points lower, or 1%. The S&P 500 shed 1.1%, and the Nasdaq Composite COMP, -0.95% slid 0.9%.
According to Colas, the phenomenon of a “Fed Drift”, which sees that equities have tended to rally into and through FOMC meetings and hold their gains the day after, no longer works.
The New York Federal Reserve Bank studied data from 1994 to 2011, which showed the S&P 500 index normally rose 24 hours before the scheduled FOMC announcements. It then drifted sharply higher in the morning of the announcement, and was on average flat, both in the hours immediately after the decision and on the following day.
Markets are pricing in a hike of 75 basis points, with futures showing a 16% chance of a full percentage point increase, according to CME’s FedWatch Tool. Investors expect the Fed will not only set a new Fed funds rate but will give them a glimpse to how high it will go in the future.
According to Larry Adam, chief investment officer at Raymond James, the company foresees an additional 75 basis points before year-end, which will be combined at the November and December meetings and bring the policy rate to 4%.
“First, the action taken thus far has already impacted the more interest-rate sensitive areas of the economy, especially the housing market,” Adam wrote in a client note dated Sept.16. “Second, although the easing of inflation has been more stubborn than expected, there are a number of real-time indicators that suggest it will cool further in the months ahead (e.g., promotional activity, declining ocean freight rates, lower commodity prices).”
That is why Adam contends that the worst of this bear market is “likely being behind us” as inflation will moderate over the next year, but the path is “unlikely to be quick or smooth”.
“Over the coming weeks, the bear market will likely take time to digest the inflationary data flow with back-and-forth trading,” Adam wrote. “With this in mind, we recommend not chasing rallies and using pullbacks as opportunities to accumulate favored stocks for the next bull market.”