Can Fed Save The Day?

The U.S. stock market is under tremendous pressure as traders are worried about an economic recession. Over the past three days, the S&P 500 index has plunged over 9%; it is officially trading in bear market territory. Something that can lift sentiment -- or make it even worse -- is when U.S. central bankers conclude their two-day meeting on Wednesday.

Last Friday, we saw the U.S. Consumer Price Index record another eye-popping number, and data confirmed that inflation is sitting at a multi-decade high. The CPI m/m data came in at 1.0%, while the forecast was at 0.7%. In addition to this, we also saw the U.S. Prelim UoM Consumer Sentiment data plunging to 50.2 against the forecast of 58.1.

Traders are worried that inflation in the U.S. hasn't reached its peak level, and it is highly likely that we may have to wait a few months to a few quarters before we can see things begin to cool down. The fact that inflation hasn't reached its peak level, let alone its retracement to pre-covid levels, is making traders anxious. Moreover, the massive plunge in U.S. consumer sentiment data has made traders more worried. It is clear that with this low consumer sentiment, an economic recession is only a matter of time.

To make matters worse, traders are concerned that the recent inflation reading has pushed the Fed further into a tight spot. Speculators are anticipating that Federal Reserve officials will be pushed to consider the biggest interest-rate hike since 1994 when they will announce their decision tomorrow.

Fed Chairman Jerome Powell previously indicated that he only wants to increase interest rates gradually. He indicated an interest rate hike of 50 basis points during his press conference in early May. Powell said that his guidance is dependent on economic data, and the fact that inflation data has outpaced expectations changes the situation, and as a result, investors are now pricing a 75 basis-point increase in the interest rate at this week's meeting.

Wall Street giant Goldman Sachs has also shifted the goalpost on its interest rate target for the coming meeting, and it believes the Fed will increase the interest rate by 75 basis points this week and in July. There is an echo of this in Nomura's call, which also believes that Jerome Powell has no option but to adopt an even more aggressive approach and an interest rate of 75 basis points is the most likely scenario.

Powell and his colleagues are already suffering reputational damage for calling inflation a transitory matter. Market players are disappointed that the Fed didn't act early to remove stimulus in a timely fashion. Fear of another a monetary policy mistake is very much the focal point among traders now. Investors believe that increasing interest rate while economic data is already flagging recession flags could push the U.S. economy into a depressionary environment.

Looking at the current economic data and the odds of the future interest rate hikes, I think the path of the least resistance for the S&P 500 is skewed to the downside. We are likely to see much higher volatility in the market when the Fed announces its monetary policy. Traders aren't going to like the idea that Fed has become more aggressive. The VIX index, a measure of fear sentiment, crossed above the 30 mark yesterday, and it is likely to remain elevated.

It seems likely that the Fed will struggle to calm investor's nerves on Wednesday, and the bear market is likely to continue for some time until we reach a peak in inflation data.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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