Will Fed Slow Policy Tightening at Tomorrow’s Meeting? Investors Suggest ‘Cautious Optimism’

US Senate Committee on Banking, Housing, and Urban Affairs hearing on the confirmation of Jerome H. Powell, of Maryland, to be Chairman of the Board of Governors of the Federal Reserve System, Washington, District of Columbia, USA - 11 Jan 2022

After the Federal Reserve announced a tightening policy that included interest rate hikes and bond tapering, the stock market — particularly the S&P 500 and Dow Jones — began a rapid descent. Since then, the Fed eased its policies once again. The S&P 500, Dow and NASDAQ have already begun to correct in advance of the Fed’s meeting on Jan. 26.

The Dow went from an opening of $34,070 to a close of $34,420 on Mon, Jan. 24. Investor’s Business Daily said there could be “something of a relief rally on Wednesday,” but cautious optimism should abound.

IBD’s Jed Graham wrote that the Fed underestimated rapid, persistent high inflation and the tight labor market. In the midst of tightening monetary policy, the risk is that inflation will continue. If the Fed continues to tighten at that point, Graham asserts, it’s the “typical recipe for a recession.”

Economists are divided on predictions. Wall Street experts believe the Fed will shrink the balance sheet by $2.5 trillion over the next few years, but will let it occur naturally as bonds mature. Deutsche Bank economists believe the Fedswon’t start to shrink the balance sheet until summer. Nomura economists, on the other hand, believe the Fed will stop buying bonds by mid-February, which would be quicker than the original March date announced at the December Fed meeting.

Whatever the pace, tightening is certain to occur, which will mean additional market corrections. In 2018, Federal Reserve chief Jerome Powell refused to issue a “put option,” which could prevent the market from falling below a certain point. He stated that the correction would have to be “significant” and “lasting” for the Fed to take such a measure. The Federal Open Marketing Committee meeting on Jan. 26 should reveal the Fed’s next steps. But one thing is for certain: the stock market will be worth watching this week.

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