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The Fed will raise rates next week, but Powell could be the most important

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Federal Reserve Chairman Jerome Powell speaks during a news conference following a meeting of the Federal Open Market Committee on May 04, 2022 in Washington, DC. Powell announced that the Federal Reserve was raising interest rates by half a percentage point to combat record inflation.

Win Mcnamee | Getty Images

The week ahead could come down to what Federal Reserve Chairman Jerome Powell had to say at 2:30 p.m. Wednesday afternoon.

Powell briefs the press after the two-day central bank meeting. The Fed is widely expected to raise its federal funds target rate range by half a percentage point, but May inflation data made markets jittery about whether the Fed might be even more aggressively or predict a faster pace of future rate hikes.

The Fed will release new economic and interest rate forecasts at 2 p.m. ET. But that’s all Powell says about the summer and fall rate hikes that could help pave the way for turbulent financial markets. Stocks and bonds have been volatile as investors fear inflation may not peak and Fed rate hikes could trigger a recession.

“I really think the bottom line is what Powell is talking about at the conference and does he give anything like firm guidance for September,” said Michael Schumacher, head of macro strategy at Wells Fargo. “If he does, he would only do it if he was going to be a warmonger, and if he doesn’t, people will see him as a pacifist.”

Schumacher said the fed funds futures market reflected a 56 basis point rise for Wednesday. One basis point is equal to 0.01 percentage point.

After Friday’s much higher than expected consumer price index for May, stocks tumbled. For the week, the S&P 500 was down 5.1%. The index on Friday, at 3,900 with a loss of 2.9% over the day.

“The market wants clear and convincing evidence that the Fed can achieve this without triggering a recession,” said Lori Calvasina, head of US equity strategy at RBC Capital Markets. She said the market will take inspiration from economic data. “Maybe you’re stuck in purgatory for a while.”

Friday’s inflation report was a negative catalyst for markets that were already pricing in worries about runaway inflation and recession fears. The CPI rose 8.6% year-on-year, well above the 8.3% expected by economists polled by Dow Jones.

It also fueled debate over whether the Fed would consider a 75 basis point rate hike and continue at a more aggressive pace of rate hikes. Barclays and Jefferies both changed their forecasts on Friday to include a 75 basis point hike for next Wednesday, although other economists still expect half a point.

Goldman Sachs economists on Friday revised their forecast to include a half-point rise in September, in addition to a half-point rise on Wednesday and another in July.

JP Morgan economists expect Fed officials to deliver new interest rate forecasts that reflect a faster pace of policy tightening, but they still see a half-point increase on Wednesday . They expect the Fed’s median forecast for interest rates to point to a year-end fed funds rate of 2.625%, well above a forecast of 1.875% in March.

“Chair Powell has signaled a desire to guide expectations rather than surprise expectations. With little apparent appetite for an upside surprise, the course appears set for a 50 basis point hike next week,” they said. noted JP Morgan economists.

RBC’s Calvasina said she was awaiting comments from Powell and did not expect any surprises from the meeting. She said she was encouraged that some Fed officials appeared ready to raise rates more quickly at the start of the year and allow room for maneuver later.

“I think the markets like it. It shows they’re not on autopilot,” she said. “It reflects that they don’t want to damage the economy too much. I would like to hear more comments on this flexibility.”

Besides the Fed, there are a few major economic reports on the calendar next week, including the Producer Price Index on Tuesday; retail sales Wednesday; housing starts on Thursday and industrial production on Friday. The four reports cover the month of May.

There are only a handful of gains, including Oracle on Monday.

Recession alert?

In the bond market, Treasury yields rose after the hotter inflation report, but the yield curve also flattened. This means that shorter duration yields, such as the 2-year, have moved closer to longer-duration yields, such as the 10-year.

On Friday, the 2-year Treasury yield hit 3.06% and the spread was only 10 basis points. If the 2-year were to cross above the 10-year, the curve would reverse, signaling a recession.

Calvasina said the stock market, for now, only forecasts a shallow recession. The S&P 500 has fallen an average of 32% in more traditional recessions, and in this cycle it has fallen nearly 20%.

The strategist said there is a 60% chance that the market has already bottomed. “I think the valuations have become reasonable enough that you can go through your shopping list and buy the names you wanted to buy,” she said.

For equity investors, the Fed remains a challenge, but small caps may be an area that has been shot down enough.

“I think there’s a bit of a thirst and a bit of a hunger to chase valuation opportunities, and I think small caps are as good as anything,” she said.

Calendar for the coming week

Monday

Earnings: Oracle

Tuesday

FOMC begins two-day meeting

6:00 a.m. NFIB Small Business Survey

8:30 PPI

Wednesday

Earnings: Jean Wiley

8:30 a.m. Retail

8:30 a.m. Import prices

8:30 a.m. Empire State Making

10:00 a.m. Business inventories

10:00 a.m. NAHB Home Builder Survey

2:00 p.m. Fed statement and projections

2:30 p.m. Fed Chairman Jerome Powell briefs the media

4:00 p.m. ICT data

Thursday

Earnings: Adobe, Kroger, Commercial Metals, Jabil

8:30 a.m. Initial Claims

8:30 a.m. Start of housing

8:30 a.m. Philadelphia Fed Manufacturing

8:30 a.m. Survey of business leaders

Friday

8:45 a.m. Fed Chairman Jerome Powell offers welcoming remarks at a conference on the international roles of the U.S. dollar

9:15 a.m. Industrial production