The Federal Reserve wants markets to fall – here’s what that means for investors (2024)

We’re in a bear market – change the way you invest Everything is collapsing at once – here’s what to do about it

Not being a Fed-watcher, I have been rather slow to this particular narrative I’m afraid, and it only really dawned on me last week as I was losing money trying to catch falling knives in the stockmarket.

It was Zoltan Pozsar writing for Credit Suisse who switched on the lightbulb for me. He’s the new rockstar among institutional market strategists.

A couple of other analysts have reached the same conclusion. It’s this: the Federal Reserve and America’s other policy-making powers that be, actually want the stockmarket lower.

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The Federal Reserve really does want to fight inflation

I’ve heard so much hot air coming out of government officials’ mouths over the years that I think my mind is actually programmed now not to believe a word they say.

It’s not that I’m treating what they say with a healthy dose of cynicism; I’ve reached unhealthy levels of cynicism. My default, so low is my trust, is now not only not to believe a word they say, it is to assume they are lying. Probably not a good place.

It turns out that sometimes those in power do actually tell the truth. I got my first surprise dose of this earlier this year from Liz Truss, the foreign secretary, when she warned that the Russian troops on the other side of the Ukrainian border were about to invade.

Pull the other one, I thought – Russia wouldn’t do that. It turned out that Truss was talking straight, and her intelligence was correct.

When US president Joe Biden said his top economic priority was getting inflation down, my inner cynic muttered: “yeah, course it is mate.” It turns out what he was saying might actually, believe it or not, be true.

The Federal Reserve’s primary mandate is to keep inflation down. It might be that its chief, Jerome Powell, is taking this mandate at face value. All that stuff about his hero being Paul Volcker might even be true too.

Lower asset prices help the cause.

Back in 2008, and for many years since, everyone in Policymakerland was worried about deflation, and every effort went into staving it off. So we got QE (quantitative easing), ZIRP (zero interest rate policy) and all the rest of it. We got very used to it. It went on for so long, it became normalised. The idea that they would ever do anything else seemed far-fetched.

But, no, in Policymakerland they are genuinely worried about inflation, and so asset prices are not going to be defended. Au contraire. They want them to fall.

Bear markets mean financial conditions tighten. Tighter financial conditions mean lower money velocity and lower inflation, according to modern definitions at least.

The Fed is talking tough, and it might be that talking tough does a lot of the job for them – and they might not have to actually act as tough as they talk.

If they can get stock prices down a bit, house prices down a bit, and a lot more caution around the place, with just a bit of jawboning, then the need for higher interest rates will diminish, and the Western world might not actually implode.

Falling cryptocurrency markets help the cause too. There won’t be that particular thorn in the Fed’s side exposing the shortcomings of fiat money.

Tighter conditions will put some upward pressure on unemployment, which means the upward pressure on wages will go away too, and that will help reduce inflation.

If this has to happen some time, that time is now, in the second year of an election cycle. Come 2023, the priority will shift to getting the economic conditions in place to win the next election. Part of this of course is lower inflation, but they will want the correction in the past and asset prices moving back up again.

OK. So if you buy this theory – how far do stocks fall?

How low can the S&P 500 go?

Currently we are at 3,880 on the S&P 500, having been as high as 4,800, so we are off about 20%. Another 10% or 15% would take us to the low 3,000s.

Best-case scenario, I’m going to say 3,600 – that’s the post Corona-panic high. Worst case? Down around 3,000 at the 2019 highs. Most likely, I’m going to guess somewhere in the middle at 3,400 – the 2020 pre-lockdown highs.

But the bottom line is this: the “print money and protect asset prices at all costs” narrative has gone; it’s history.

The issue is no longer deflation, by their definition. Now it’s about inflation. They’ve been able to ignore it for years by crooked measures, ignoring asset prices and all the rest of it. They can’t any longer. That’s what they are now fighting.

As they say, “don’t fight the Fed”.

It won’t be the case forever – elections have to be won – but it seems the case for now.

Psychologically, we might need some despair and maximum pessimism before the bear market can be deemed over. There still seems to be too much optimism about. We need to be at that point of perception that the bear market is entrenched and we are never going to get out of it before it can end; we haven’t reached that point yet.

Everything bubbles on the way up, everything pops on the way down.

It might be, by the way, that UK stocks – small and large – turn out to be a very good place to hide (I’m not saying the UK economy – stockmarkets and economies are different beasts).

My reasoning? A presentation by fund manager Gervais Williams that I saw at the UK Investor Show last weekend. UK stocks have been rubbish for 20 years, but in the inflation of the 1970s they were one of the best global places to park capital. Fingers crossed the same thing happens this time around.

Dominic’s film, Adam Smith: Father of the Fringe, about the unlikely influence of the father of economics on the greatest arts festival in the world is now available to watch on YouTube.

SEE ALSO:

We’re in a bear market – change the way you invest

Everything is collapsing at once – here’s what to do about it

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FAQs

How does the Fed affect investors? ›

Rising or falling interest rates can also impact the psychology of investors. When the Federal Reserve announces a hike, both businesses and consumers will cut back on spending. This will cause earnings to fall and stock prices to drop, and the market may tumble in anticipation.

Read On ›

What happens to stocks when the Fed cuts rates? ›

The stock market is unlikely to soar when the Federal Reserve starts cutting interest rates. That's the conclusion of an analysis of all initial rate cuts since 1994, the year when the Fed began publicly announcing changes to its target federal-funds rate.

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What happens to the stock market when the Federal Reserve lowers the risk free rate? ›

Key Takeaways. When the Federal Reserve changes interest rates, it has a ripple effect throughout the broader economy, affecting both stock and bond markets in different ways. Lower rates make borrowing money cheaper. This encourages consumer and business spending and investment and can boost stock prices.

What stocks do well when interest rates fall? ›

Dividend stocks: Dividend stocks typically pay out a quarterly dividend, which can grow over time. This kind of stock tends to do relatively better than an average stock when rates are falling, in part because the payout becomes more attractive.

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Does the Fed protect investors? ›

Federal securities laws seek to promote fair, orderly, and competitive markets that protect investors from undisclosed risk while fostering innovation and market access.

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Can the Federal Reserve take money out of the economy? ›

As the central bank of the US, the Fed has the power to either pump cash into the banking system (by buying Treasury securities) or take cash out of the system (by selling them). This concept is known as “open market operations.”

Tell Me More ›

What happens to gold if the Fed cuts rates? ›

Over the last two decades, gold has consistently delivered positive returns during periods of interest rate cuts. Gold and interest rates typically have an inverse relationship and price tends to rise when interest rates fall and go down when they increase, Anuj Gupta, Head Commodity & Currency, HDFC Securities said.

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Where to invest during rate cuts? ›

When interest rates fall, preferred shares generally offer better yields than common stocks and bonds. Dividend-paying stocks. Companies with reliable dividends and those with a long history of boosting their shareholder payouts become more attractive as rates rise and fixed-income yields drop.

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How to profit from falling interest rates? ›

The consumer discretionary, technology, real estate, and financial sectors have historically been especially likely to outperform the market when rates fall and earnings rise. Financial stocks look particularly appealing, due to how inexpensive they've recently been.

What are the 10 best stocks to buy right now? ›

Company (ticker)	Analysts' consensus recommendation score	Analysts' consensus recommendation
ServiceNow (NOW)	1.49	Strong Buy
Assurant (AIZ)	1.50	Strong Buy
Howmet Aerospace (HWM)	1.50	Strong Buy
Insulet (PODD)	1.50	Strong Buy

21 more rows

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Should I invest in bonds when interest rates are falling? ›

Because bond prices typically rise when interest rates fall, the best way to earn a high total return from a bond or bond fund is to buy it when interest rates are high but about to come down.

Read The Full Story ›

Where to put cash when interest rates are low? ›

CDs, high-yield savings accounts, and money market funds are the best places to keep your cash when it comes to interest rates. Treasury bills currently offer attractive yields at the lowest risk. Learn how they compare in terms of yield, liquidity, and guarantees.

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How do investors react to a raise in interest rates by the Fed? ›

“Higher rates mean investors are inclined to pay less for a dollar of future earnings in a company because they can earn more competitive current yields in lower volatility investments like cash and bonds,” says Haworth.

Get More Info Here ›

How do interest rates affect investment? ›

When interest rates rise, stock markets typically decline. Because borrowing becomes more expensive, people and businesses tend to spend less. This decreased spending may mean companies hire less or have layoffs, see lower productivity and face reduced earnings. These effects often cause stock prices to fall.

How does the Fed affect the money market? ›

The Fed uses three primary tools in managing the money supply and pursuing stable economic growth: reserve requirements, the discount rate, and open market operations. Each of these impacts the money supply in different ways and can be used to contract or expand the economy.

Who does the Fed funds rate affect? ›

Fed rate hikes increase your borrowing costs. This affects consumer loans, credit card interest rates, and business financing, which in turn can dampen consumer spending and investment. Mortgage rates typically follow suit, making home buying less affordable and reducing refinancing activity.

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