Wall Street’s Optimism Faces FOMC’s Test

Strong January as well as latest gains in the stocks market are driven by hope that the US interest rate hiking cycle is close to its end and that a pause is on the cards. If investors’ expectations are eventually found mistaken about this hope, a drop could be very potential.

Wall Street has welcomed a change of tone at the start of 2023. There have been concerns about a severe economic downturn, these fears are retreating because data indicates that inflation is easing, therefore, there are hopes that the Fed will soon be done raising interest rates.

In the first four weeks of the year, this optimism has resulted in a 6.2 percent jump in the S&P 500 and an even bigger rally among big technology stocks. Tech stocks were among the worst performers in 2022 because of their sensitivity to rising interest rates, and their rally now is helping to drive the broad market higher.


Stocks’ gains have been led by a steady flow of data that shows the economy continues to grow, while inflationary pressure is easing. On Tuesday, for example, a key measure of pay and benefits — the Employment Cost Index — rose less than economists had expected, and the S&P 500 jumped 1.5 percent. But this positive data faces a big test on Wednesday, with caution leading to a 0.3 percent decline in the S&P 500 index in morning trading.
The Fed is widely expected to raise interest rates by just 25 basis point later in the day, the smallest jump since March. Higher interest rates raise costs for companies and consumers, and weigh on profits and spending, so investors are welcoming the prospect that the central bank could start to ease off.

In some quarters of the financial markets, the optimism has gone even further. Even though the Fed has signaled that it will raise its benchmark rate above 5 percent, a growing number of investors are betting that the rate won’t ever get that high. That view has set the stage for a battle between the Fed and the financial markets.

The stock market gains actually undercut the Fed’s efforts to slow the economy enough and tame inflation. The last time stocks began to rise, over the summer, Fed Chair, Jerome Powell, had to publicly warn that the fight against inflation was far from over. That was enough to send stock prices lower again.
Powell will have a chance to do this again on Wednesday when he speaks to the press after the Fed announces its decision.

Powell is expected to be hawkish in his press conference to counteract the trends he still fears towards a resurgence of inflation. That could trigger a pullback in the market.