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Rocky stock market faces Fed test with eyes on tightening plans

A volatile stock market faces a critical test next week, when the U.S. Federal Reserve is expected to raise interest rates and release more information on its monetary policy tightening plans. to fight against soaring inflation.


Concerns over an increasingly hawkish Fed have helped push the benchmark S&P 500 index (.SPX) down around 11.5% so far in 2022, on track for the biggest drop. as a percentage to start the year for more than half a century. April marked the biggest monthly decline since the start of the coronavirus pandemic in early 2020.


As investors have raised their expectations of how aggressively the central bank might tighten monetary policy, many fear the Fed won’t be able to keep the economy afloat as it battles the worst inflation. for almost four decades.


Compounding concerns over monetary policy, investors have been annoyed by everything from rising bond yields to war in Ukraine and more recently lockdowns in China. The market is also entering a historically weaker six-month period for equities.


We were going to have, I think, more risky, choppy and volatile markets here for a while, just because of the uncertainty, said Randy Frederick, vice president of trading and derivatives for Charles Schwab in Austin, Texas. , who said that “things turned the other way from the start of the year, coming off a strong fourth quarter at the end of 2021.


Investors widely expect the Fed to raise rates by 50 basis points at the end of the central bank meeting on Wednesday. They are also bracing for signals from Fed Chairman Jerome Powell on the future path of interest rates, the central bank’s plans to shrink its balance sheet and his view of when inflation will recede. Policymakers raised rates in March by 25 basis points, the first increase since 2018.


If the Fed continues to expect high levels of inflation and doesn’t see it moderating going forward, that will be a concern for investors,” said Michael Arone, chief investment strategist at State Street Global Advisors “This will mean the Fed continuing to raise rates and tighten monetary policy, which is what the market expects, but perhaps even more aggressively.”


Beyond next week’s action, policymakers have coalesced around an overall increase in the federal funds rate to at least 2.5% by year-end.


How officials persist in viewing the current pace of inflation after March’s consumer price index posted an 8.5% annual increase, the biggest rise in more than 40 years, will be crucial. for tightening plans.


Given that there are indications that inflation has started to peak, said Kei Sasaki, senior portfolio manager at Northern Trust Wealth Management, if there is an even more resounding hawkish tone coming out of this meeting, that could certainly be seen as a negative.”


As investors brace for a tightening of monetary policy, bond yields have jumped this year, with the yield on the 10-year Treasury rising to around 2.9%, from 1.5% at the end of 2021.


This has particularly put pressure on technology and growth stocks, whose valuations are based on estimated future cash flows that are undermined when investors can earn more on risk-free bonds. The Russell 1000 Growth Index (.RLG) has fallen around 18% so far this year.


Meanwhile, investor sentiment is austere. The percentage of individual investors describing their six-month outlook for stocks as “bearish” rose to 59.4%, its highest level since 2009, according to the latest weekly survey from the American Association of Individual Investors.


Certainly, after the recent market drop, the Fed’s actions could provide some comfort if they avoid raising further concerns. Following the Fed’s planned rate hike in March, the S&P 500 rebounded more than 8% in the following two weeks.


Investors will continue to keep an eye on corporate results, after a mixed week of megacap earnings. Reports from Pfizer (PFE.N), Starbucks (SBUX.O) and ConocoPhillips (COP.N) are expected next week, among others.


With the calendar shifting to May, seasonality is also emerging as a possible factor for investors. The strongest six months for the S&P 500 since 1946 were November through April, when the index rose an average of 6.8%, according to the CFRA.


In comparison, the index gained only 1.7% on average from May to October.


However, more recently, the trends have not been as strong. Over the past five years, the S&P 500 has averaged a gain of 7.2% in the May-October period versus 5.5% for November-April, according to Reuters analysis.


“I don’t know how important seasonality will be this time around,” said Jack Ablin, chief investment officer at Cresset Capital Management.


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