What Happens When the Unstoppable Stock Market Meets the Immovable Fed?

The stock market has had a strong start to the year, with the Dow, Nasdaq Composite, and S&P 500 all rising. This has been despite the fact that the Federal Reserve has been raising interest rates. Fed Chairman Jerome Powell is expected to remind the market of the central bank's policy when he speaks this coming week.

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The Dow Jones Industrial Average gained 1.8% this past week, while the S&P 500 advanced 2.5% and the Nasdaq Composite rose 4.3%. It was the S&P’s third gain in four weeks, putting the index up almost 14% from its bear-market low in early October.

There's no big secret about what's driving the stock market rally. Inflation has been falling, and the market is betting that the Fed will see enough improvement to stop hiking interest rates in the near future. That would be good news, of course, because investors' big fear is that the central bank will tighten right into a recession.

The Fed is expected to announce a rate hike on Wednesday, which could push back against the bulls' expectations for the market. The reason for the rate hike is that Fed officials don't see the labor market loosening enough to hit 2% inflation. This could be a problem for the markets, as inflation is already coming down.

Inflation is decreasing. However, Federal Reserve officials are still cautioning that there will be more interest rate increases in the future. The reason for this is that they do not believe the labor market is improving enough to reach the 2% inflation goal.

Inflation, as reflected in the consumer price index or the personal-consumption expenditures deflator, is still higher than the Fed’s target of 2%. This means that the central bank is not happy with the easing of financial conditions that occurs anytime the stock market rallies. Expect the chairman to have something to say about that.

There are many different types of stocks, and each has its own set of characteristics. For example, common stocks represent ownership in a company, while preferred stocks offer certain privileges, such as priority in the event of a bankruptcy. There are also different types of stock exchanges, such as the New York Stock Exchange (NYSE) and the Nasdaq.

Citigroup economist Andrew Hollenhorst writes that Powell will likely emphasize that rates will stay elevated for some time, despite the softer inflation data.

The Fed's potential interest rate hike could put a stop to the recent stock market rally. The Nasdaq has gained 11% this month, its best January since 2001. This has caused the S&P 500 to look expensive at 17.9 times earnings, up from 16.7 at the end of 2022. Even though companies such as Microsoft and Texas Instruments are still guiding earnings lower, there are still reasons to be bullish on the long-term trend of digital transformation.

Despite the current market conditions, there are still reasons to be bullish on the long-term trend of digital transformation. In the coming week, investors should watch for signs of continued progress in this area.

The S&P 500 has had trouble surpassing the 4100 level in recent days, as sellers have come in to knock it down several times. However, the index has definitively breached its 200-day moving average this week, which may signal more gains to come. Year to date, the S&P 500 is up about 6%.

So far this year, the index has increased by about 6%. This week's gains have pushed the market definitively past its 200-day moving average.

John Kolovos, chief technical strategist at Macro Risk Advisors, believes that even if the Fed sounds moderately hawkish, the index could still inch its way to that level. However, he thinks that a more substantial rally is unlikely without more conclusive proof that the economy is heading for a soft landing.

Ultimately, that's not a great setup for the market in advance of the FOMC meeting. Chris Harvey, chief U.S. equity strategist at Wells Fargo Securities, says that Powell will have a continued focus on tighter for longer, and that's not what the market wants to hear.

It's as if it hasn't been listening.