Federal Reserve 'Might' Do Another Huge Rate Hike, But Powell Sparks Dow Jones Rally

The Federal Reserve delivered a huge rate hike, but the Dow Jones extended gains after Jerome Powell said another huge hike may or may not come in September.

Federal Reserve Chair Jerome Powell said that a third rate hike in September "could" be appropriate. The Fed raised rates by 75 basis points for the second consecutive meeting. The Dow Jones Industrial Average, which had been making modest gains, exploded into a rally when Powell spoke. And the Nasdaq also made a strong surge.

Powell said that the Fed will take care to implement its policy, despite the fact it is prioritizing the reduction of inflation over concerns about a slowing economy. Powell's news conference included a dash optimism that the Fed could engineer a softer landing, and a hint that inflation is improving.

Powell stated that there was a sense of the labor market returning to balance. Powell cited weaker results from the Labor Department's survey of households and anecdotal reports from businesses.

Stock market investors should take away this key message: Powell will cushion the economy's landing to the maximum extent possible. Powell has made it clear that, while there is still uncertainty over how high the Fed's rates will need to be raised to get inflation down to 2% again, he won't raise them any higher or faster than needed. Powell sees himself differently from Paul Volcker, who was the Fed chairman that killed the last inflation by raising the Fed's main rate to 20%.

The Fed meeting did not change much in reality. Prior to the meeting, the odds of a 75 basis-point increase at the Fed’s next meeting on Sept. 20-21 were just above 50%. CME Group's FedWatch website reports that they dropped to 44% at the end of his press conference.

Powell's press conference showed that the Fed doesn't want to stop a rally in the stock market. Powell's news conference revealed that the Fed doesn't want to stand in the way of a stock market rally.

Fed policy is implemented by tightening the financial conditions. This is reflected in market-based interest rate and stock prices. Stock prices that are higher, and can have a wealth-effect on the economy, will help counteract tightening policy.

Powell said policy could be adjusted if the financial conditions loosen in a way that boosts demand contrary to Fed's intentions. Powell might not be too concerned about the stock market's rise due to the ongoing balance sheet tightening. By September, the Fed's balance sheet is expected to contract by $95 billion per monthly.

There is some risk in the Fed's approach. Bill Ackman of Pershing Square capital management said it best: "The more people believe that the Fed is going to reverse course immediately, the less effective rate increases will be at reducing inflation and the more rates the Fed has to raise."

Gas and other commodities are now cheaper, suggesting that inflation has finally peaked. A slew of unexpectedly poor economic data is now piling up.

The Fed's statement did not suggest any major shift in inflationary trends. "Inflation is still high, due to supply and demand imbalances resulting from the pandemic and higher energy and food prices."

The statement offered a mixed view of the economy even as red flags for recession are increasing. Recent indicators of production and spending have weakened. The job growth has been strong in recent months and the unemployment rate is still low.

It is too soon to make a Fed change course. The consumer price index for June showed a 9.1% increase in inflation and the 372,000 jobs added last month are still fresh. The Fed will have two more months' worth of data to review before its next meeting. When it is clear that the economy is in a downward spiral, policymakers will be forced to make tough decisions. The slowdown in the federal taxes deducted from employee paychecks indicates that this could happen as early as next Friday's report on July jobs.

The Dow Jones rose 0.4% shortly after the Federal Reserve's policy statement was released. After Powell's speech, the Dow Jones gained 1.4% by the time the market closed. The S&P 500 jumped 2.4%, and the Nasdaq composite soared 4.1%.

Dow Jones and other major indices reached their bottoms in mid-June just after the Fed raised rates by 75 basis points. After May's consumer prices index, which showed a surge in inflation to an all-time high of 8.6%, the Fed tightened its plans. The Fed's policymakers were on high alert after June's inflation data showed a still higher rate.

Many Wall Street strategists believe that the Fed will not hike rates as much as they feared due to softer economic data, lower inflation and a stronger US dollar. The Fed appears to be pausing rate increases as slow growth becomes a recession. Many believe that a rate reduction could be considered by spring 2023.

Since mid-June, the trend has been lower Treasury rates and higher stock prices.

The Dow Jones Industrial Average has still gained 6.3% since its closing low on June 17. This reduced its loss from its all-time high closing on Jan. 4, to only 13.7%. The S&P 500 has recovered 6.9% of losses, and is now 18.25% away from its all-time high close. The Nasdaq is up 8.6%, but still 28% below the peak.

After spiking to close to 3.5% in the past, the yield on 10-year Treasury bonds has now fallen. The 10-year yield fell by 1 basis point on Wednesday to 2.78%. Short-term rates, which are more closely linked to Fed rate movements, have fallen several basis points.

Dow Jones, among other major indices, has broken above its 50-day line for the first since April. This reflects an optimistic view of a Fed pivot. However, the current uptrend is under pressure. To stay informed about the current market trends and how they affect your trading decisions, read IBD’s The Big Picture daily column.

Follow Jed Graham @URL on Twitter for economic policy and financial market coverage.

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