Don’t fight the Fed

Stocks tumbled last week as investors belatedly heeded that old Wall Street maxim: don’t fight the Fed.

Indices have rallied hard since October as investors bet slowing US inflation data would force a Federal Reserve pivot. Fed chairman Jerome Powell has consistently guarded against this assumption, basically saying: I’m more hawkish than you think, go easy on the pivot talk.

Powell repeated that message last week, drawing investors’ attention to the Fed’s so-called dot plot. It shows the Fed expects rates to exceed 5 per cent at the end of 2023, some 75 basis points higher than market expectations. The Fed is almost unanimous on this point: 17 of its 19 senior members think rates will top 5 per cent.

Stocks fell slightly following Powell’s hawkish comments last Wednesday, only to suffer their worst decline in months the following day. That skittishness reflects a continued market debate.

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Some say Powell wants to keep markets sober for now but will soon pivot. Others think markets are underestimating the Fed and that this nonchalance puts stocks at risk of revisiting bear market lows in 2023. This debate has raged all year and it’s not ending just yet. As Morgan Stanley cautions, expect more Fed hikes and more volatility in 2023.