Fed meeting: Will Powell throw Dow Jones a bone?

Friday’s CPI report settled a lot. Inflation is still peaking and the Federal Reserve will have to raise interest rates higher and faster than many on Wall Street expected. But the policy announcements from today’s Fed meeting will still answer some key questions that will help determine how long it will take for the Dow Jones Industrial Average to bottom and eventually begin a sustained rally.




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The quarterly economic forecasts, which will be released along with the policy statement at 2 p.m., may provide some answers. Namely, how high do Fed policymakers believe rates need to rise and for how long. But Federal Reserve Chairman Jerome Powell’s post-meeting press conference is likely key to stock markets’ reaction.

After five straight sessions in which the Dow Jones fell 8.5% and the S&P 500 fell 10.2%, could the markets be primed for a relief rally? To some extent, the bad news – increased Fed urgency – is good news. Because the faster interest rates rise, the more likely it is that the economy will slow down to contain inflationary pressures.

However, there is a high risk that any rally, just like the one that followed the May Fed meeting, will be short-lived.

Super large rate hike by the Federal Reserve

Financial markets are still pricing in nearly 70% odds of a half-point rate hike on Monday, according to CME Group’s FedWatch page.

The decision should depend on which of the two targets the Fed prioritizes. Policymakers want to raise interest rates as soon as possible to dampen inflationary pressures. However, when markets slide, the Fed generally tries to avoid giving them an extra boost lower. A surprise 75 basis point hike could have done just that.

However, the Fed may have sidestepped the surprise factor by leaking to the Wall Street Journal that 75 basis points is definitely on the table. That prompted Goldman Sachs and other investment firms to predict an outsized rate hike. Markets now see a 75 basis point move as safe.


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The Fed’s urgency was certainly heightened by the CPI report, which showed headline inflation hit a 40-year high of 8.6%. Rising food and energy prices are one reason for this. But Fed officials could be particularly concerned if non-energy services prices rise 5.2%, the fastest pace in 30 years. This includes big spending categories like rent and health care.

As a result of this extended wave of inflation, the June University of Michigan survey showed that consumer expectations about future inflation are beginning to rise significantly. With psychology playing a large role in inflation dynamics, rising inflation expectations increase pressure on the Fed to act vigorously.

How restrictive will the rates become?

At his May 4 press conference after the Federal Reserve’s last meeting, Powell hedged when asked if interest rates needed to be hiked to restrictive levels. “It’s certainly possible,” he said, but added: “We can’t know that today.”

While there is no precise level at which rates will become hawkish, policymakers believe the long-term neutral rate is somewhere around 2.4% to 2.5%.

The latest economic forecasts released in March showed that the Fed’s overnight interbank lending rate will peak in 2023 at 2.8%, which is slightly hawkish.

New forecasts will certainly show rates moving into more hawkish territory. The FedWatch site now shows the benchmark federal funds target range increasing to a range of 3.75% to 4% by February. That’s a full percentage point more than markets were expecting just a month ago.


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Have markets priced in too much tightening? We will get a picture of the new rate hike forecasts. Fed policymakers may not be the best forecasters, but of late they seem to be more open about what it takes to keep inflation in check.

After the May 4 meeting, Powell struck a new tone, warning that “pain” may be unavoidable. Consistent with his recent candor, Powell has said the unemployment rate could rise a few notches.

The latest round of Fed forecasts in March essentially saw the unemployment rate stabilizing at 3.5% through 2022, 2023 and 2024. New forecasts this week will probably not be quite as ideal.

How long will interest rates remain restrictive?

Aneta Markowska, chief financial economist at Jefferies, sees the current burst of inflation as a throwback to the late 1960s. In both periods, an extremely tight labor market and high prices mutually reinforced each other.

In the earlier episode, she wrote, the Fed’s aggressive tightening pushed the unemployment rate up to 6% from about 3.5%. But the Fed declared victory too soon, paving the way for another decade of wrestling with high inflation.

“Faced with a feedback loop between prices and wages, the Fed needs to stay tight longer,” Markowska wrote. “We certainly don’t expect the current Fed to make the same mistakes. Therefore, we expect the nominal overnight rate to reach 4% this cycle. Therefore, we also expect it to fall more slowly in the next downturn.”

Fed forecasts for the interest rate outlook in 2023 and 2024 could show that tightening monetary policy could have legs.

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Federal Reserve policies indirectly affect the economy by affecting financial conditions – a combination of market interest rates, asset valuations, credit spreads and the ability of companies to raise capital. If the Fed urgently works to cool demand, policymakers will not want household wealth to recoup much of this year’s losses. That implies a fairly low ceiling for a short-term stock rally.

But what about the floor? Despite a few “volatile days,” Powell said at a WSJ conference on May 17 that financial markets “are weathering this pretty well.”

At the time, the Dow Jones Industrial Average was 12.4% below its 52-week high, while the S&P 500 was down 16.4% and the Nasdaq Composite was down 27.4%.


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At Tuesday’s close, the Dow’s loss had increased to 17.5%, while the S&P 500 was down 22.1% and the Nasdaq was down 32.6%.

The big question is whether Powell still thinks the markets are doing well. Could Powell throw a bone at the Dow Jones?

Probably the best investors can hope for is that Powell will say that financial conditions have tightened sharply and are nearing reasonable levels. That light at the end of the tunnel could be enough to spark a rally.

However, Powell could stress that financial conditions need to remain tighter for some time to come.

After Russia’s invasion of Ukraine, Powell assured that the Fed would contribute to, not detract from, stability. Powell’s underlying message, however, was that controlling inflation will provide that stability.

Conclusion: Don’t get carried away; It’s a long tunnel.

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