All year, investors have been trying to figure out where the economy is headed after two-plus years of turbulence since the pandemic started in early 2020. The market is also trying to understand where the Federal Reserve is at in its work to bring down inflation. But considering the number of conflicting factors, including high inflation, low unemployment, and declining gross domestic product (GDP), investors have largely been operating in a constant state of uncertainty. After struggling all year, stocks rallied in July, but many investors aren’t sure if we are out of the woods just yet.
However, there could be more clarity coming tomorrow at the Fed’s annual Jackson Hole Economic Symposium, which could mean a big move for stocks — in one direction or the other. Let me explain.
Powell is about to take the podium
All eyes will be on Fed Chairman Jerome Powell tomorrow at 10 a.m. Powell will address the public and speak about his view of the economy and where things could be headed in the near term, which has seemingly baffled the market all year long.
For much of the year, inflation has been at a 40-year high as high savings rates, the Fed’s easy-money policies, and pent-up demand drove consumer prices up across the board. The Fed seemingly found itself behind the eight ball and had to begin rapidly raising its key benchmark overnight lending rate, the federal funds rate, including with two consecutive 75-basis-point rate hikes (0.75%) at its June and July meetings. The Fed is expected to institute another 75- or 50-basis-point hike at its meeting in September and keep raising interest rates into 2023.
All of this has investors wondering if this kind of hawkish monetary policy will tip the economy into a recession or even a severe recession. After all, the U.S. economy has already seen GDP contract for two straight quarters, which is considered a technical recession.
But new data for July hinted that inflation may be starting to peak, although more data is likely needed to really confirm this. This led many to believe the Fed may start to slow the pace of rate hikes, which sent stocks rallying. Furthermore, the labor market, which tends to be a lagging indicator, has remained strikingly strong with unemployment at 3.5% in July, making some wonder if the Fed can indeed engineer a soft landing for the economy.
Still, not all are convinced. Ex-Treasury Secretary Larry Summers said earlier this week that he thinks the Fed has confused the market and should acknowledge that it likely will not be possible to “get inflation all the way down without unemployment up.”
While this wouldn’t necessarily be good news, the market invests based on what’s going to happen, so a continued state of uncertainty makes it tough for stocks to gain any real momentum.
How the market could react
It’s always hard to predict how the market will react to news, but Powell’s comments could certainly get stocks moving. There is debate over whether the Fed will hike rates by 0.50% or 0.75% at its September meeting. I don’t think Powell will give an outright answer or necessarily turn dovish, but if his comments hint at a 0.50% hike, I’m guessing markets will respond positively.
If Powell goes down Summers’ suggested path and says that unemployment will likely get worse as the Fed fights inflation, I am far less certain about how the market will respond. On one hand, that’s bad news. On the other hand, at least it provides some clarity and gives the market a road map.
Ultimately, I think we’ll see some decent movement in stocks tomorrow after Powell’s comments, so be prepared and don’t panic if it happens. Do not try to buy or sell the news, but continue to invest with a healthy long-term outlook. That will be less risky and likely more profitable than any short-term catalysts.