The stock market carnage this year continues to get worse, with the S&P 500 recently falling into a bear market amid rising fears of a looming recession. Investors have grown increasingly concerned about the Federal Reserve’s ability to achieve a “soft landing”—bringing down inflation without plunging the economy into a recession—as it aggressively tightens monetary policy.
Most Wall Street experts predict that the Federal Reserve will raise interest rates by 50 basis points, which would bring the federal funds rate to 1.25%, at its policy meeting on Wednesday.
After a hotter-than-expected inflation reading (consumer prices hit 41-year highs) last week that stoked recession fears, however, some experts are now calling for a 75 basis point rate increase. In recent days, several major firms including Goldman Sachs, Barclays and Jefferies have all changed their forecasts of a 50-basis-point increase to a 75 basis point hike.
The last time the Federal Reserve raised rates by 75 basis points was in November 1994 when the central bank was able to orchestrate a soft landing by tightening monetary policy ahead of rising inflation. That increase was part of a series of rate hikes by then Fed Chair, Alan Greenspan, who raised rates seven times over the course of 13 months, from 3% to 6%, between early 1994 and early 1995 in an effort to keep the economy from overheating.
In 1994, stocks were only slightly negative for the year (falling just 1.2%), and the Fed was able to avoid a recession and stocks rebounded 34% in 1995. What’s more, after the rate hike in November 1994, stocks dropped only slightly before rebounding ahead of another rate increase in February 1995, according to data from CFRA Research.
Can the Fed achieve the same kind of soft landing in 2022? Stocks are already down 22% this year, and while the Fed was tightening ahead of inflation in 1994, today it is “scrambling to catch up,” says James Stack, president of InvesTech Research and Stack Financial Management.
“The biggest difference today with the successful ‘soft landing’ of 1994-95 is how extraordinarily far the Federal Reserve is behind the curve,” and it’s essentially been “caught asleep at the switch,” Stack argues. “When the Fed should have started incrementally raising interest rates early last year with emerging signs of inflation, they instead continued to stimulate the economy – both with 0% interest rates, and ongoing monthly bond purchasing,” he adds.
Back in 1994, the Fed was raising interest rates to levels that were much higher than the year-over-year change in consumer prices, points out Sam Stovall, chief investment strategist for CFRA Research. “This time around, inflation is [rising at a pace] significantly faster than interest rates—so it’s a totally different situation where the Fed has to act much more aggressively.”
Despite the myriad of negative factors weighing on markets today, one positive is that the economy remains fairly solid, says Charles Lemonides, founder and chief investment officer at ValueWorks. “The biggest negative is that conditions are so good that the Fed has to make them worse by cooling off the economy—so that may be a position of strength similar to in 1994.”
If the Fed is forced to increase rates by more than expected on Wednesday, how will the stock market react? The best-case scenario: Stocks trade sideways and then mount a small relief rally after the Fed announcement, according to Lemonides. “That said, laying odds is next to impossible—one could make a case for stocks to rally or sell off regardless of whether the Fed increases by 50 basis points or 75.”
Stovall thinks markets will be “disappointed” if the Fed doesn’t increase rates by 75 basis points, however, as it “wouldn’t be enough to reassure investors” in the face of inflation continuing to surge to new highs. If the central bank sticks to its previous narrative and only raises rates by a half-percentage point, that would show that they are “wedded to procedure rather than responding to the data.”
“The economy is still apparently on stable footing, but the problem is that the confidence underneath that footing is crumbling,” says Stack. He points to several troubling signs, including plunging CEO confidence, small business outlooks and consumer sentiment. “In short, the Fed totally blew it” and there is “little doubt we are heading toward a probable hard landing for the economy,” he adds.
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