Will the Fed stop the hike at 4.00%?

Federal Reserve Chairman Jerome Powell

Stocks jumped again today ahead of the Fed’s rate hike as traders continued to “buy the dip”. The Dow, S&P and Nasdaq Composite all gained significantly, with energy stocks leading the way.

Analysts were quick to offer headshots on the market after its recent rise.

“The case for the current bear market is that the Fed will continue to tighten monetary policy, take liquidity out of the market and cause equities to plummet,” said David Donabedian, chief investment officer of CIBC Private Wealth US.

“But the market rally this week showed that the economy continues to hold up, supported by favorable economic reports.”

“Favorable economic reports?” What was “favorable” about the Atlanta Fed’s recent GDPNow cut that now forecasts negative GDP growth for the third quarter? What was “supportive” for the JPMorgan Purchasing Managers’ Index (PMI) which fell last month to its lowest level since June 2020? What was “favorable” in the weak jobs report that showed a worse-than-expected increase in unemployment (3.7% reported vs. 3.5% expected)?

The only thing these reports favored was a Fed pivot. These were signs of economic weakness, not strength. The rally over the past few days came in response to an oversold market and hopes Powell would become dovish in his post-FOMC remarks this afternoon.

Despite the newfound optimism on Wall Street, at least one mainstream pundit made a seemingly correct call this morning:

“I think you have to believe the Fed,” said Richard Clarida, who served as the Fed’s former vice chairman from 2018 until January of this year.

“The message I’m getting is very clear: failure is not an option for Jay Powell. I think they’ll go 4% to hell or flood if I were to put it in two boxes,” he said.

“Inflation is way too high.”

The federal funds rate is currently 2.5%. This means that if Clarida’s prediction comes true, rates will only rise another 1.5% (following two more 75 basis point hikes) before the Fed steps down.

In reality, rates may have to go much higher to stop inflation. Clarida framed her prediction as a warmongering warning, but in reality it was a dovish fantasy. It’s also exactly what Ark founder Cathie Wood wants the Fed to do in the coming months.

“In Jackson Hole, President Powell invoked Volcker’s name twice directly, twice indirectly. Today’s COVID supply shock inflation has nothing to do with the inflation of the 1970s that started with “guns and butter” in 1964, and accelerated after Nixon ended the gold exchange standard in 1971,” she tweeted yesterday.

“The Fed increased the federal funds rate 10-fold from 0.25% to 2.50%, five times Volcker’s 2-fold increase from 10% to 20% in the early 1980s, when consumers and businesses s “were inflation-adjusted for 10 to 15 years. But now they’re in shock. Housing is collapsing.”

Wood concludes:

“The Fed seems [be] responding to 15-month COVID-related supply shocks the same way Volcker fought inflation that had been brewing and building for 15 years. I wouldn’t be surprised to see a major political shift in the next three to six months. »

If Clarida is correct and the Fed stops the hikes at 4.00% in October, the pivot will occur within two months, well before the Wood period. This definitely skews bullish.

And, if Powell suggests this is going to happen at his post-FOMC press conference this afternoon, expect stocks to rally even more than they have already.