After a year spent parsing Federal Reserve chair Jerome H. Powell’s comments for clues about the direction of interest rates, some stock investors are going their own way.
On Wednesday, despite Mr. Powell announcing a 0.25 percentage point increase in rates, pledging that there are more to come, and suggesting that rates won’t be cut at all in 2023, the S&P 500 rose 1 percent. The gains added to a rally that’s lifted shares by more than 7 percent this year.
In the bond market, Treasury yields, indicative of the cost of borrowing for the U.S. government and a benchmark for mortgages and other loans, fell.
This is not how things have gone for most of the past year: Rising interest rates raise costs for consumers and companies, and the prospect of more increases has typically triggered stock market declines.
But lately, investors have latched on to signs that inflation is slowing, encouraging many to forecast that the end of the Fed’s rate increases is near, even as the central bank has warned that their fight against inflation is far from over.
Trading on Wednesday illustrated the growing dissonance between investors and the Fed. Going by the market’s move, it appears that investors are increasingly distrustful of the Fed’s own forecasts.
“He did say ongoing hikes but I still don’t believe it,” said Andrew Brenner, head of international fixed income at National Alliance Securities. Mr. Brenner believes the rate increase made Wednesday will be the Fed’s last. He said the market had lost faith in the Fed’s forecasts after a year in which interest rates unexpectedly rose 4.5 percentage points. “This Fed has been more wrong than right and I think you can fight the Fed,” he said.
Mr. Brenner is not alone in his prediction. Though most investors are still forecasting another 0.25 percentage point rate increase in March, that outlook — reflected in trading in futures markets — is still below the Fed’s own forecasts for two more quarter-point raises. Markets are also pricing in a cut in interest rates later this year, something Mr. Powell tried to rule out on Wednesday.
“I just don’t see us cutting rates this year,” he said.
Investors weren’t moved. The 10-year Treasury yield, which underpins borrowing costs around the world, fell 0.1 percentage points on Wednesday to 3.42 percent. The two-year Treasury yield, which is sensitive to changes in Fed policy, also fell 0.1 percent points to 4.12 percent.
Technology stocks, among the worst performing in 2022 because of their sensitivity to higher interest rates, have rallied this year. The Nasdaq Composite, stuffed full of technology stocks, jumped 2 percent on Wednesday. It has climbed nearly 13 percent this year, notching its best start to a year since 2001.
Still, the stock-market rally Wednesday is not going to be the final word on this matter.
Rising stock prices and falling bond yields have created a problem for the Fed, enriching investors and making it easier for them to borrow, undercutting efforts to pull down still high inflation.
“This loosening of financial conditions is undoubtedly not what the Fed was aiming for, and we expect a cacophony of Fed speeches in the coming weeks will aim to reorient the Fed’s message,” said Gregory Daco, chief economist at EY Parthenon, Ernst & Young’s strategy consulting arm. “In other words, the infernal tango will continue as the Fed and markets try to find synchronized rhythms once again.”
The last time stocks began to rise markedly, over the summer last year, Mr. Powell had to publicly warn that the fight against inflation was far from over. His caution then was enough to send stock prices sharply lower again.
This time, Mr. Powell struck a more balanced tone, acknowledging the resilience of the economy and that he still expects it to grow this year. He said that investors appear to think inflation will fall more quickly than the Fed expects, allowing the central bank to reduce interest rates sooner.
“We have a different view, a different forecast really,” said Mr. Powell, noting that the central bank is willing to adjust its policy if it is wrong.
The jump in stock prices this year has left some investors worried that markets are being too optimistic, with the Fed’s impact on the economy, consumers and companies still to be fully realized. And if Mr. Powell is unsatisfied with the markets’ response, he will get another chance to set things straight when he speaks at the Economic Club of New York next week.
“We are shifting toward asking, how much damage has the Fed done?” said Chris Murphy, a derivatives strategist at Susquehanna International Group. “I think investors are underappreciating that.”
