The stock market has misread signals from the Fed and a pivot on rate hikes is still far from happening, research firm says

  • The stock market misread the Federal Reserve’s July FOMC meeting, according to TS Lombard.
  • An interest rate pivot from the Fed is far away from happening and a 75 basis point hike is likely in September.
  • “Inflation is easing but the US job market remains too hot for investors’ own good,” TS Lombard said.

Investors shouldn’t hold their breath when it comes to a pivot from the Federal Reserve on its interest rate policy, according to a Monday note from TS Lombard.

The investment research firm said the stock market misread the Fed’s July FOMC meeting, in which Fed Chairman Jerome Powell declined to give future rate hike guidance and instead said the central bank would solely focus on incoming data to determine its next moves. 

For investors, Powell’s comments served as an early indication that future rate hikes could potentially be less than the outsized 75 basis point rate hikes that happened in June and July if inflation shows signs of cooling, and it led to a more than 10% rally in the S&P 500.

But not so fast, according to TS Lombard. The firm’s analysts said that another 75 basis point rate hike will happen at September’s FOMC meeting, followed by another 75 basis points in rate hikes by the end of the year. That would put the Fed Funds rate at 4%, well above its current rate of 2.5%.

“Inflation is easing but the US job market remains too hot for investors’ own good,” TS Lombard said in its reasoning for why the Fed will continue on with its rate hikes. The unemployment rate fell to 3.5% in July after more than 500,000 jobs were added to the US economy.

TS Lombard argued that contrary to comments from Powell, the Fed Funds Rate is nowhere near its targeted neutral level.

“Nobody (including the Fed) really knows what the ‘neutral’ policy rate is. Yet with the rate of job creation still solid, wage growth running at 5.75% SAAR MoM and initial jobless claims well below levels consistent with a severe economic downturn, it is hard to argue that neutral is at 2.5%,” TS Lombard said. “The funds rate has a long way to go in real terms.”

The prospect of further interest rate hikes as the yield curve inverts and the economy muddles along does not bode well for the stock market, according to the note. 

“All this means that stocks remain caught between limited scope for multiple expansion and a deteriorating earnings outlook. The bar for material re-rating in the face of Fed hikes and negative earnings revisions looks high, especially given how elevated earnings are versus trend,” TS Lombard said.

The S&P 500 is down 13% year-to-date, but has rallied more than 10% from its mid-June low following resilient second-quarter earnings and a perceived semi-dovish pivot from the Fed. According to TS Lombard, don’t expect stocks to see big moves into year-end. 

“At the very least, intensifying headwinds to profitability imply a low speed limit for equities, capping the upside,” TS Lombard concluded.

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