After wild swings, investors look to the Federal Reserve to calm the market

Published Wed, Jan 26 20226:36 AM EST

Patti Domm @in/patti-domm-9224884/@pattidomm

Investors are wondering whether the Federal Reserve can calm the extreme volatility in the stock market, but it's unclear whether it can deliver a soothing enough message. Typically, it's a dovish central bank, or one that is easing policy that is viewed as positive for risk assets like stocks. But economists do not expect the Fed to change the hawkish tone it has worked hard to deliver, when it releases its statement at 2 p.m. ET Wednesday. The central bank is expected to make clear that it is ending its bond buying by March and will be ready to raise interest rates possibly the same month. Fed Chairman Jerome Powell is also expected to reinforce the same policy stance when he speaks at 2:30 p.m., and he could mention that the Fed is also discussing paring down its nearly $9 trillion balance sheet, another form of tightening policy. But that does not necessarily mean the Fed's policy stance will result in a sell-off Wednesday afternoon. "I think the fact that we'll get past the event without additional hawkish commentary could be calming," said John Briggs, head of global strategy at NatWest Markets. "I don't think he'll contribute to volatility." It's the subtleties of the Fed message that some strategists say could help or spook the stock market. The harsh sell-off and volatility since the start of the year has been largely blamed on the Fed's transition from it's easy money policies to tightening. That stance became very clear to the market in December when the Fed accelerated the end of its bond buying program and issued a forecast with three rate hikes for this year. "I don't think he needs to be any more hawkish than he has been," said Briggs. "I don't think he needs to adjust the market because that's already been done. I don't think he can be dovish because he has an inflation fight and a political environment that he has to deal with." Stocks closed out Tuesday lower, after another session where stocks swung higher and lower by multiple percentage points. "This amount of volatility in front of the Fed is absolutely understandable, given the action of the last two weeks," said Julian Emauel, Evercore ISI chief equity, derivatives and quantitative strategist. "What it really is, is that the market believes it knows what the Fed is going to guide it to, which is essentially four hikes and QT [quantitative tightening] starting at midyear or later. The way the market's been trading it's as if the market believes that the potential for a policy mistake to where the Fed overtightens is enormous." Quantitative tightening is a reference to the Fed's plan to ultimately shrink its balance sheet, which has doubled since the start of the pandemic. The Fed could choose to stop replacing the maturing securities on its balance sheet or ultimately sell assets it is now holding. Emanuel said the market ignored the Fed's message throughout December, until tech stocks started to sell off this month. Since then economic data, like the 1.9% decline in December retail sales, has made investors uneasy about the Fed's rate hiking message. It is also unclear how long the soft patch will last and whether it is just a result of the omicron variant of Covid and will fade. That makes Powell's comments even more important. The Fed chairman is expected to acknowledge a weaker economy and emphasize that the Fed will be watching the incoming data. "The problem that I have right now is that the message is so finely balanced between the need to be data dependent, but he needs to make sure we know he's serious about fighting inflation," said Emanuel. "Whatever comes out, the market could likely trade defensive [Wednesday] into Thursday." Emanuel said it will be key whether Powell helps remove some uncertainty or not. "I think there's a potential there's going to be more uncertainty because the message is so challenging," Emanuel said. If Powell were to change his message, that would be confusing to investors. "A dovish Powell may actually cause a knee jerk rally because people will think less the Fed will be less aggressive, but to us that's a rally that gets sold into because what he's telling you is there's much more uncertainty than you thought," said Emanuel. James Paulsen, chief investment strategist at Leuthold Group, said volatility ahead of a Fed meeting is not unexpected. "Every time there's a Fed meeting, there's always volatility, and this one just got more extreme," he said. "I think it might be perceived that way for a couple of reasons. We've already had the emotional sell-off, or at least a good chunk of it." Paulsen said investors are wary because they can't know whether the soft-patch, which seems temporary, really is or not. "The worst periods are when you are feeling great and the Fed says something," he said. "This time, we're already braced for bad. Even if it is bad, and it's not as bad as feared, that will help." The S & P 500 plummeted to an intraday low of 4,222 on Monday and held above it Tuesday, closing at 4,356, down 1.2%. Emanuel said the market sell-off has put some stocks close to an attractive entry point for investors, but he expects more selling even if there is a bounce back. "A bottom was put in, but probably not THE bottom," he said. Paulsen said the market is showing signs of finding a bottom. "We're probably going to spend some time testing that low," he said.

Federal Reserve Chairman Jerome Powell is seen delivering remarks on screens as a trader works on the trading floor at the New York Stock Exchange (NYSE) in New York City, December 15, 2021.

Andrew Kelly | Reuters

Investors are wondering whether the Federal Reserve can calm the extreme volatility in the stock market, but it's unclear whether it can deliver a soothing enough message.