Will Fed Interest Rate Hike Stall Stock Market Gains?

Will bulls be stopped in their tracks – again – thanks to the Federal Reserve (Fed)?

Bullish sentiment took hold last week as the three major stock market indexes all rallied higher and, despite losses today, closed October with a grin worthy of a happy jack-o-lantern.

As the darkness of Halloween washed over the evening, the Dow locked in an almost 14% gain; the S&P 500 rallied almost 8%; and the Nasdaq – despite the technology sector slipping – added 3.9% for the month.

All the treats on Halloween may turn into a tricky market environment if the Fed lets loose another market-bludgeoning interest rate hike.

Will Fed interest rate plans stall market gains?

The next Fed meeting – the Federal Open Market Committee (FOMC) – kicks off tomorrow with an announcement expected Wednesday on the next phase of raising benchmark interest rates.

The Fed has said it will raise rates by another 75 basis points, or .75%. This despite news reports that have implied the central bank is hinting at possibly easing interest rate hikes starting next year.

Market participants are watching for any indication from the Fed moving from a hawkish stance to a more dovish position on monetary policy.

“At this time, the markets are anticipating a .75 percent rate hike,” said Mary Ellen McGonagle, Senior Managing Director of Equities at Simpler Trading. “Equally important will be the notes from the meeting that provide insights into future hikes as will Fed Chair Jerome Powell’s comments.”

In the market today all three major indexes struggled.

The Dow closed at 32,732.95 points to lose .39% (dropping 128.85 points on the day). The Nasdaq was hit hardest, falling to 10,988.15 points for a 1.03% tumble while the S&P 500 dropped .75% to 3,871.98 points.

Words from the Fed can make a difference in how the stock market moves.

“As you may recall, this year’s prior bear market rallies in March and July were both stopped in their tracks by talk of an aggressive rate hike policy from Fed Chair Powell,” said Mary Ellen.

She is also watching movements in the U.S. Treasury bond interest rates. She noted that interest rates pulled back slightly last week but remain elevated with the yield on the 10-year note at the 4% level.

“Declining interest rates were one of the hallmarks of the March and July rallies with earnings reports also driving the markets higher during July,” Mary Ellen said. “Any hint of a possible lower rate hike in December in the .5 percent  range from Powell would be a huge boost for the markets.”

Energy, healthcare sectors boost market

Mary Ellen has turned an eye to the energy sector as a point of stability in the uncertain stock market this week.

“The energy sector has been the largest contributor to earnings growth for the S&P 500 for Q3 2022 with companies such as Exxon Mobil (XOM) reporting one of its best quarters in history on the heels of record profits,” Mary Ellen said. “In turn, XOM raised their quarterly dividend.”

A variety of energy stocks are due to report earnings this week and Mary Ellen will be following the strength and weaknesses in the results.

“Their results as well as investors’ response could set the pace for this group in the coming weeks,” said Mary Ellen.

She is also watching the healthcare sector which has developed a new uptrend thanks to key large-cap biotech stocks selling more drugs. Some companies reporting earnings deserve caution, Mary Ellen said, but gains in the larger companies are worth following.

“Larger biotech stocks have a history of performing well even in difficult periods such as the 2008 bear market when both Celgene (CELG) and Amgen (AMGN) posted healthy gains while the markets fell 37%,” Mary Ellen highlighted. “Primarily, the demand for their innovative therapies remained in place despite a difficult economy and stock market.”

Weak earnings tailwinds may give way to Fed influence

While corporate earnings reports the last two weeks have been above most analyst estimates, Mary Ellen is cautious that the tailwinds behind these results may be fading.

“While strong results will most likely continue to drive select stocks and their peers higher, ultimately investors are buying stocks because they’re hopeful for a pivot by the Federal Reserve in their aggressive rate hike campaign,” Mary Ellen said. “This is why this week’s interest rate news, and Fed Chair Powell’s press conference following, will carry such importance.”

She doesn’t want to put too much faith in recent rallies with Fed news on the immediate horizon.

“While we’ve highlighted stocks as being in buy zones, we would keep positions smaller in size until after Wednesday’s Fed meeting results,” Mary Ellen said.

Also leading into the midweek Fed announcement are the Volatility Index (VIX) and U.S. Dollar Index (DXY) moving higher to start the week. When the VIX and DXY gain ground, the equities tend to lose.

Traders will need to put all these variables together as they make decisions about trading in this environment.