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Investors Cautious Over Strong Economy

economy
Stock market chart | Image by Jirapong Manustrong

Investors are practicing caution following recent stock market volatility.

The U.S. economy’s resilience was on display in January as U.S. equities surged back to life and employers continued their hiring spree. Still, a number of other economic factors have prompted apprehension from investors and institutions over the stock market’s recent rally.

The U.S. stock market rallied heavily at the beginning of 2023, with major indexes like the S&P 500 and Nasdaq jumping more than 6% and 12%, respectively. However, the attitude from investors quickly shifted in early February as many came to terms with the Federal Reserve’s plan to keep interest rates higher for longer.

On February 1, the Fed approved its eighth interest rate increase, a 0.25% hike that raised the fed funds rate to 4.5%-4.75%.

The Federal Reserve has aggressively raised rates to prevent inflation from roaring back to new highs. In June 2022, U.S. inflation hit a peak of 9.1%, the highest reading in more than four decades. Since then, inflation has eased lower to a January reading of 6.4%, a 0.1% drop from the month before but still well above the Fed’s 2% target goal.

With a continuation of January’s robust stock market rally seemingly less and less likely, Eric Johnston, head of equity derivatives at Cantor Fitzgerald, expects stock prices to drop much lower.

“I’m very negative right now on equities,” said Johnston, according to reporting by The New York Times. “I think the move we have seen in the rate market, some of the inflation numbers that have come out and the expectation that the economy will be fine is all fairly problematic.”

While the Federal Reserve is trying to shrink the economy, the White House is trying to stimulate growth in the economy. These two competing policy forces have complicated the Fed’s job and increased the probability that loosening financial conditions would trigger a rebound in inflation. If this occurs, the U.S. will be forced to deal with higher prices and higher rates.

Currently, Fed members are projecting the need for about two more quarter-percentage-point increases, which would raise the Fed’s target range to 5%-5.25%. A more reasonable possibility, according to New York Fed President John Williams, is that the target range goes as high as 5.25%-5.5% by June.

“Our work is not yet done,” Williams said during a February 14 speech at the New York Bankers Association. “Inflation is still well above our 2 percent target, and it is critically important that we reach that goal.”

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