The stronger-than-expected economic news and the stubborn inflation reports over the past few weeks suggest the Fed will likely continue to hike interest rates.
Healthy employment, evidenced by recent job reports of higher payrolls than expected and the unemployment rate declining to multi-decade lows. Robust employment numbers and firmer retail sales reports showing resilient consumers in front of rising inflation may prevent the Fed from pivoting.
Investors prefer to see the economy and inflation slow as it would allow the central bank to pivot earlier. Higher-than-expected inflation numbers, including the Consumer Price Index, Producer Price Index, and Personal Consumption Expenditure Price Index, can push the central bank to delay the pivot.
Markets now expect the Fed to raise rates to as high as 6% for the Feds target rate, increasing the risk of a harder landing than anticipated. On top of the rate hikes, the Fed reducing its balance sheet are restrictive and will drain further liquidity from the financial market.
How will stocks and other financial markets react to further rate hikes?
The pertinent question is whether last year's sharp stock market decline and an equally abrupt contraction in P/E valuations have alleviated an overbought market condition, allowing for a market reset.
The stock market and the economy may have already priced in the bulk of the bad news during 2022. If you look at previous bear markets, including the 2007-2009 global financial crisis/great recession, the 2000-2002 tech/telecom dot.com bubble, and the sharp bear market declines during 1973-1974 and 1946–1949, each of these bear declines fell in advance of economic recessions.
Financial conditions may have already tightened so much that the bulk of the pain has occurred during 2022. Unless the economy follows the path of the 2007-2009 global financial crisis/great recession or the 1929-1932 great depression, the mid-Oct 2022 low may have been the bear market bottom.
However, it does not necessarily imply this is the start of a structural bull. Unless this is another V-pattern recovery, 2023 may be the start of another extensive base-building period for US stocks. A sideways trending market can set the stage for a critical breakout or breakdown of its trading range.
From a technical perspective, it would imply the SPX Index entering into a sideways trading range between 3,400 +/- 200 (Aug 2020 V-pattern breakout, 50-61.8% retracements from Mar 2020-Jan 2022 rally, the Sept/Oct 2020 and Jun/Oct 2022 lows) and 4,800 +/- 200 (Jan/Mar 2022 highs) into 2023.
A breakout above 4,800 suggests 1,200-1,400 points or an SPX target of 6,000-6,200. On the other hand, a breakdown below 3,400 warns of a decline toward 2,000-2,200.
In the meantime, we can expect 2023 to be choppy and volatile. Since SPX is currently trading at 4,048.42 (3/6/23) or near its mid-point (4,100), it would imply a neutral market with a risk/reward profile of 1:1.
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