Investors are braced for a pivotal Federal Reserve meeting Wednesday, when central bank officials will lay out their plans to fight persistent inflation that has roiled financial markets in recent weeks.
After a wobbly start, the Standard & Poor’s 500 gained .69 percent on Monday, following one of the index’s worst weeks of the year, in which the benchmark stock index fell nearly 5 percent.
The moves come at the end of a volatile summer of trading in which investor optimism in a brighter outlook for the economy eroded, a short-lived stock market rally was extinguished, and prominent investors and business leaders increasingly warned that the worst may be yet to come.
On Wednesday, the Fed will announce its latest increase in interest rates and, crucially, revised economic forecasts by its policy makers, which provide a view on future rate changes. Jerome Powell, the Fed’s chair, will also answer questions from reporters about his own expectations, which could end up sending stock and bond prices higher or — as many fear — lower.
The Fed’s meeting is important “because of what it could mean for the direction of the stock market for the rest of the year,” said Kristina Hooper, the chief global market strategist at Invesco. “The Fed has been the key driver of the stock market this year, and it has been mostly bad.”
One of the primary drivers for the changing mood in markets has been evidence that suggests inflation remains more elevated than expected, despite the Fed’s aggressive moves to try to lower it with a series of rate increases. In turn, investors have come to expect the Fed will need to raise interest rates higher and faster than they once thought, raising costs for companies and consumers in a bid to slow the economy and rein in rising prices.
The yield on the two-year Treasury note, which is sensitive to changes in Fed policy, rose Monday to 3.95 percent, hitting the highest point since 2007 and continuing a remarkable run since the start of the year, when it was under 1 percent. Rising yields flow through to mortgages, credit cards, business loans, and other borrowing costs, crimping economic activity.
Futures trading suggests the Fed will raise rates by three-quarters of a percentage point Wednesday. A small number of investors, however, are betting on a full-point increase, which would be the biggest Fed increase since 1984 and would probably result in stocks lurching lower.
Investors will parse Powell’s comments after the interest rate decision is announced. In August, he was seen by some as turning more “hawkish,” acutely focused on lowering inflation by raising interest rates, even if it meant pushing the economy into a more severe downturn. That contrasts against policy makers being described as “dovish,” or setting monetary policy that is more stimulative for the economy, as when it seemed to officials early last year that higher inflation could be transitory.
On Wednesday, anything more severe than investors have already heard from Powell, or that they expect to see in the latest economic projects, is likely to send stock prices lower. A more dovish tilt to the Fed’s forecasts or the chairman’s comments could lift stock prices, although that is far from many investors’ expectations.
“He cannot sound dovish. He will not sound dovish,” said Mark Cabana, an interest rate strategist at Bank of America. “He will sound very much as someone who is committed to ensuring price stability and doing whatever it takes to achieve that.”