The stock market rallied after the Fed, and some strategists say it may have gotten too giddy

Published Wed, Jul 27 20225:34 PM EDTUpdated Wed, Jul 27 20226:53 PM EDT

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

Stocks rallied hard Wednesday after investors viewed the Federal Reserve as dovish, even as it raised rates by 0.75 percentage points. But investors may have gotten too giddy about the central bank much too soon, warn some Fed watchers. The S & P 500 rose 2.6%, and the Nasdaq surged 4.1%. Fed Chair Jerome Powell acknowledged that the central bank's actions were causing some slowing in the economy as did the Fed statement. Powell also said the fed funds rate could be at 3.25% to 3.5% by year end, as Fed officials have projected in their September forecast. "I don't think he was as hawkish as I thought he would be" said Vince Reinhart, chief economist at Dreyfus and Mellon. "I think the market is appropriately loving what Jay Powell said at the press conference because Powell said the latest summary of economic projections was about right, and therefore the pricing associated with that is about right, and that will be sufficient to get the outcome everyone hopes for which is a decline in inflation." Reinhart said Powell was much less hawkish than he expected. "The market's not taking the Fed seriously enough. The Fed is seriously committed to hiking," said Jim Caron, head of macro strategies for global fixed income at Morgan Stanley Investment Management. "If equities rally and credit spreads narrow that means the Fed could feel the need to tighten even more and they could get even tougher. ... I'm a little skeptical on this. I'm happy about it, but I'm skeptical." As stocks rallied, bond yields fell. Yields fall when bond prices rise. The 2-year yield, which most reflects Fed policy, fell to 2.98% in late trading Wednesday, from a high of 3.06% just ahead of the Fed's 2 p.m. ET rate announcement. In the fed funds futures market, traders bet the Fed would raise rates to 3.26% by December, down from 3.38% before the meeting. Reinhart noted that Powell also said some time the Fed would have to slow the pace of firming. "This is a green light to current pricing," he said. "He's firming policy rate and wants to be liked about it. And if markets like it, he's very comfortable with that outcome. The question is does the market outcome produce the economic outcome." Reinhart noted that tighter financial conditions, meaning higher yields and a weaker stock market, may be required to get the outcome the Fed would like to see. The Fed has raised its fed funds rate to a range of 2.25% to 2.50% since March. But inflation continues to gallop higher, with the consumer price index rising 9.1% in June , the highest since November 1981. Caron said stock investors heard Powell say the economy and the jobs market were strong and he's not expecting a recession. "Look what rates are doing, they're not really rising. Okay the worst is over. The Band-Aid is ripped off and equities will resume," said Caron. The closely watched 10-year yield was at 2.78% in late trading, near where it was when the Fed announced its rate hike. The fact that Powell acknowledged that the Fed could slow its hiking after providing a burst of tightening was seen as a positive, strategists said. The chair offered no concrete guidance for the September meeting, and said the Fed would be data dependent. "I think the reason this is providing some relief to the equity market is the Fed is acknowledging that there can be an impact on growth, to the economy, based on their policy," said Gargi Chaudhuri, head of BlackRock's iShares investment strategy, Americas. "They're recognizing there are two sides of this: there's a growth tradeoff to fight inflation. Their recognition is something we heard today that we didn't hear before." Therefore, she said the market sees the Fed as willing to slow down to prevent too negative of an impact to the economy. Chaudhuri said the market was reacting to several things, including the fact the Fed stuck to a three-quarter point hike Wednesday and did not go more aggressively. It was a positive the statement reflected that the economy was slowing, and the fact that it will be data dependent going forward, she said. "They knew this was something the market would pay attention to, and they want to take sure we notice they acknowledge the slowing down of the economy" as a result of their policy, she said.