The Stock Market Is On Its Way To Setting New Records. Is The Fed Still Going To Raise Rates?

Stocks have been steadily approaching record levels, an occurrence that would not typically be a primary concern for the Federal Reserve. However, in the aftermath of an eventful three-year period marked by pandemic-induced volatility, the stock market rally has become a source of unease for the market, coinciding with the Fed's efforts to conclude its extensive rate-hiking endeavors.

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Colin Graham, head of multiasset strategies at Robeco, points out that a substantial amount of money remains in the economy, necessitating the possibility of expediting quantitative tightening (QT) or raising interest rates to facilitate a quicker liquidity drain.

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The "wealth effect" has acted as a counterbalance, suggesting that rising stock prices have boosted household wealth, leading to increased spending. Moreover, the low interest rates during the pandemic spurred borrowing among homeowners and corporations, providing a significant buffer against the Fed's rate hikes since 2022.

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Sal Guatieri, senior economist at BMO Financial Group, warns that if the stock market and home prices continue their unexpected gains, it may result in looser financial conditions, making the Fed's task more challenging and potentially necessitating further rate increases that could carry the risk of a hard economic landing.

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The Federal Reserve has made notable progress in curbing inflation, with U.S. consumer prices rising 3% in June on a yearly basis, down from the peak of 9.1% last year. It aims to maintain the rate at a 2% annual target. Market analysts attribute the market's positive performance to the effectiveness of the Fed's efforts in managing inflation.

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However, the looming concern is that rising rates and tighter financial conditions generally do not bode well for stock portfolios, historically leading to recessions. While the Fed has already raised its policy rate to 5%-5.25%, the highest since 2007, it is expected to implement another 25 basis points rate increase in its upcoming meeting.

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Despite the positive gains this year, investors remain cautious, considering the previous market selloff in 2022. While the recent inflation numbers provide some relief, it remains uncertain if the current rate-hiking cycle will differ from the past.

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The conclusion of the Fed's two-day meeting on Wednesday is eagerly awaited by the markets, with manufacturing data, a U.S. home price update, and an inflation update being among the highlights in the coming days. The Fed faces the delicate task of balancing its actions to steer the economy while considering potential headwinds to consumer spending and potential underperformance in certain sectors.

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