Yahoo Finance The stock market's biggest risk is the Fed looking backwards: Morning Brief
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Stocks have been chugging along this year, defying a lot of pessimistic predictions. Even with last week’s 2% drop, the S&P 500 has rallied by more than 17% in 2023. Rising interest rates, earnings declines, the drawn-out conflict in Ukraine, a worse-than-forecast economic picture in China – none of it has served to derail the rally.
So, what could?
Some strategists and economists are still pointing the finger at the Federal Reserve, even as it comes to the end of its hiking cycle. That’s because of the much-discussed “long and variable lags” of rate increases. That is, those hikes take a long time to hit the economy, and they do so in uneven fashion.
Mohamed El-Erian says there’s still room for the central bank to make a “policy mistake.” The Allianz advisor and president of Queens’ College, Cambridge University spoke to Yahoo Finance last week. He has consistently highlighted the strength in the U.S. economy, while raising the specter of such a mistake.
“My greatest worry is that the Fed will overtighten, that the Fed will continue pursuing an inflation target – 2% – that makes less sense for today’s structural and supply side elements,” he said.
El-Erian says the Fed’s data dependence is a problem, because the data it’s consulting is backward-looking.
“My biggest fear is by the end of the year, headline inflation will start turning up again, and at that point, if the Fed continues to be excessively data dependent, will be put in a really hard position, and we don’t want that. We want the Fed to take the long view to target medium-term inflation and make sure that we don’t unnecessarily damage economic growth in response to short-term data.”
He’s not the only one to worry about the Fed. But market participants have been confronted by both the markets and the economy defying their expectations all year. Even if the Fed has the potential in theory to choke off growth, a zoom higher from zero to 5.5% in a little more than a year hasn’t done so.
“If you look at any recession over the last 60 to 70 years, the one unifying factor, the one common denominator, has been an overzealous Fed,” said Jack Manley, global market strategist at JPMorgan Asset Management. “I wouldn’t say this time is different, but I also don’t think – at least in the first half of next year – it’s a done deal.”
Investors may not be as worried right now about the Fed in part because they’re already looking ahead to when the central bank will start cutting rates.
The June summary of economic projections, or dot plot, showed Fed governors are looking for rates to be lower by the end of 2024. Market participants are on the same page, with the majority of futures bets pricing in a range of 3.75% to 4.25% by December of next year.
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