Stocks rallied through July despite growing recession fears and dismal economic data. The rally was fueled by investors betting the US economy would slow down and the Fed would cut rates. Low rates boost stock prices, which means bad economic news is actually good for investors. Loading Loading something.
The economy is contracting and Americans increasingly fear a recession is on the horizon or already here. However, the stock market is thriving positively.
The S&P 500 jumped 9.1% in July alone, notching its best monthly gain since the post-lockout rally in November 2020. The benchmark is now at its highest level since early June. Other indexes jumped in similar fashion, indicating that the market pessimism that dragged prices down for much of 2022 may be changing.
The demonstration faces the economic context. Data released last week showed the economy shrank for a second straight quarter, amplifying concerns that the United States was heading for a recession. Inflation remains at four-decade highs. Americans’ financial cushions are quickly disappearing and their confidence in the economy is near historic lows.
But all this bad news could have a bright side for investors: A recession could force the Federal Reserve to back off its fight against inflation and cut interest rates next year, which is usually a big help for actions.
Interest rates play an important role in shaping the valuation of stocks. Lower rates boost valuations because they make companies guess cheaper. Conversely, higher rates can weigh on the market by intensifying the debt burden of companies and slowing the pace of borrowing.
The Fed has been raising rates throughout 2022 in hopes of cooling inflation. That pushed stocks lower, but the latest batch of bleak economic data has investors shifting their bets. Traders now expect growth to slow so much that the Fed will have to completely halt its rate hike plans and cut its benchmark rate to boost the economy. This outlook fueled the strong rally through July.
Of course, there’s no guarantee that investors will get the rate cuts they’re betting on. Fed Chairman Jerome Powell said on Wednesday that it will “probably be appropriate” for the central bank to slow its rate hike cycle after raising rates at the fastest pace since the 1980s.
However, there is plenty of room to slow the pace of increases before stopping the cycle. The Fed raised rates by 0.75 percentage points at both its June and July meetings, tripling the size of its typical hikes.
Fed officials have also signaled that they intend to keep raising the benchmark until 2023. Economic projections released after the central bank’s June policy meeting showed participants expected the federal funds rate to reach 3 .4% by the end of 2022. This is higher than the current range of 2.25. to 2.5%, indicating the equivalent of four more normal hikes of a quarter of a percentage point at the Fed’s three remaining meetings this year.
Members then expect the benchmark to reach 3.8% by the end of 2023 before falling back to 3.4% in 2024. That implies some easing during the year, but not enough to lower rates enough to provide a major economic boost.
During a press conference on Wednesday, Powell poured some cold water on investor confidence that a near-term rate cut was on the cards given how difficult it is now to predict where the economy and the inflation in the coming months. The Fed’s June estimates are “the best estimate” of what the Fed expects, but there is still “so much uncertainty” around the path of the economy, he said.
“You have to take any estimate of what rates will be next year with a grain of salt,” Powell said. “There’s a lot more uncertainty now about the way forward than I think there usually is, and it’s usually quite high.”
Simply put, there is no guarantee that investors will get the lowest rates they expect. But as recession fears widen and signs point to a slowing economy, the chances of a Fed pivot increase.