There's been a seismic shift in investor perspective: Bad news is no longer good news.
For the past year, Wall Street has hoped for cool monthly economic data that would encourage the Federal Reserve to halt its aggressive pace of interest rate hikes to tame inflation.
But at its March meeting — just days after a series of bank failures raised concerns about the economy's stability — the central bank signaled that it plans to pause raising rates sometime this year. With an end to interest rate hikes in sight, investors have stopped attempting to guess the Fed's next move and have turned instead to the health of the economy.
This means that, whereas softening economic data used to signal good news — that the Fed could potentially stop raising rates — now, cooling economic prints simply suggest the economy is weakening. That makes investors worried that the slowing economy could fall into a recession.
What happened last week? Markets teetered after a slew of economic reports signaled that the red-hot labor market is finally cooling (more on that later), flashing warning signals across Wall Street.
Investors accordingly shed high-growth, large-cap stocks that have surged recently to rush into defensive stocks in industries like health care and consumer staples.
While tech stocks recovered somewhat by the end of the short trading week — markets were closed in observance of Good Friday — the Nasdaq Composite still slid 1.1%. The broad-based S&P 500 fell 0.1% and the blue-chip Dow Jones Industrial Average gained 0.6%.
What does this mean for markets? Now that Wall Street is in "bad news is bad news and good news is good news" mode, it will be looking for signs that the economy remains resilient.
What hasn't changed is that investors still want to see cooling inflation data. While the central bank has signaled that it will pause hiking rates this year, its actions so far have only somewhat stabilized prices. The Personal Consumption Expenditures price index, the Fed's preferred inflation gauge, rose 5% for the 12 months ended in February — far above its 2% inflation target.
Moreover, Wall Street might be overly optimistic about how the Fed will act going forward: Some investors expect the central bank to cut rates several times this year, even though the central bank indicated last month that it does not intend to lower rates in 2023.
It's unclear how markets will react if the Fed doesn't cut rates this year. But there likely won't be a notable rally unless the central bank pivots or at least indicates that it plans to soon, said George Cipolloni, portfolio manager at Penn Mutual Asset Management.
Commentary that's hawkish or reveals inflation worries could hurt markets, he adds. "It keeps that boiling point and that temperature a little high."
What comes next? The Fed holds its next meeting in early May. Before then, it will have to parse through several economic reports to get a sense of how the economy is doing, and what it will be able to handle. Markets currently expect the Fed to raise interest rates by a quarter point, according to the CME FedWatch tool.
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