The Fed has to walk a fine line. How the stock market may react, per JPMorgan
It’s a fine line the Federal Reserve is going to have to walk on Wednesday. The Fed is widely expected to raise rates at its policy meeting that began Tuesday, a sharp departure from what investors were expecting just a few weeks ago when the central bank was anticipated to remain on hold. Fed funds futures were last pricing in a roughly 93% chance of a quarter point hike this week, up from a 33% likelihood one month ago, according to the CME FedWatch Tool. A hike seems inevitable to many traders. A succession of hot inflation data — released at a time when energy prices are rising on a war that does not seem it will conclude anytime soon — is adding pressure to the long end of the Treasury curve, which is also hurting the stock market. On Tuesday, the major U.S. stock benchmarks were down for a second day, as bond yields continued their climb. The 10-year Treasury note yield also scaled to a fresh 2007 high. The stock market reaction Wednesday will largely come down to what decision the Fed makes, as well as the messaging Chairman Kevin Warsh issues at the press conference. JPMorgan’s trading desk thinks that Warsh will have to toe a fine line for the stock market to rise. Here are five scenarios the bank sees playing out: No hike. This decision would likely add upward pressure to longer-dated bond yields as inflation expectations rise. That means the S & P 500 itself would fall 1.25% to 1.75%. 25 basis point hike, no guidance. This decision is the consensus view on Wall Street. It would contain the back end of the yield curve, and spur equities higher. The S & P 500 could rise 0.25% to 0.75% in this scenario. 25 basis point hike, remove 2025 eases. This decision could be greeted even more positively by the market. If Fed Chair Warsh suggests that the central bank could start taking back the Fed’s 2025 rate cuts, and raise rates in October and December — rather than in December and March — the decisive action could also buoy equities. The S & P 500 rises 0.50% to 1%. 25 basis point hike, higher R-star. This decision without any guidance on the R-star could have traders looking toward economic theory that suggests the current rate is too accommodative — meaning the Fed could have to hike by a full percentage point or more. The R-star refers to the neutral real interest rate, or the short-term interest rate that satisfies both sides of the central bank’s dual mandate of full employment and stable inflation. If traders start worrying the Fed could raise rates by half point hike at any meeting this year, that could hurt stocks. The S & P 500 falls 0.25% to 1% in that scenario. 25 basis point hike, crush inflation. If Warsh suggests that the fed funds rate needs to be “materially higher,” that would repeat the 2022 / 2023 hiking cycle and could end the bull market. The S & P 500 falls 1% to 2%.