Has the U.S. Stock Market Reached its Bottom?

This morning, U.S. futures traded mixed as investors caught their breath after the S&P 500 scored its best one-day gain since June 2020. Traders had found comfort in the Federal Reserve's decision to raise the interest rate by 50 basis points, which matched market expectations. One of the key takeaways that supported investor sentiment was that the Fed doesn't believe it needs to increase the interest rate by 75 basis points.

The U.S. stock market has been on a major rollercoaster for the past few months, but has it formed a bottom? There are several reasons behind the recent sell-off, like the ongoing geopolitical conflict between Russia and Ukraine, the supply chain issues due to covid restrictions, higher oil prices, soaring inflation, and hiking interest rate cycles among central banks.

Two factors that had kept sentiment down are rising inflation and fear of a monetary policy mistake by the Fed. After all, the Fed never believed that the rising inflation was a situation that needed addressing; they called it transitory. It was only recently that the Fed realized that it had made a policy mistake and that they needed to bring inflation lower and do it fast.

This particular factor triggered a major risk-off wave among investors and traders. In addition to this, if history tells us anything, it is that traders are addicted to dovish monetary policy, and whenever the Fed begins the process of hiking interest rates, the stock market in the U.S. usually falls.

The fact Fed Chairman Jerome Powell made it clear yesterday that the Fed isn't thinking of increasing the interest rate by 75 basis points changed the narrative among traders for two reasons.

Firstly, they believe that recession is less likely to occur as the Fed isn't as aggressive as they previously thought. Traders feared recession because they thought an aggressive monetary policy would kill economic growth in the U.S., so a more measured approach is seen as a positive for the stock market.

Secondly, the general sentiment in the market is now that inflation in the U.S. may have peaked. This alleviates the need for further hawkish monetary policy. Basically, if inflation has already peaked, then there is less pressure on the Fed in the upcoming meeting. The most hawkish scenario that I see is only a 50 basis point interest rate in the next few meetings. There is even a chance that the Fed may lower the pace of interest rate hikes, which would paint a much more optimistic picture for stocks.

Having said that, I do not believe that we are completely out of the woods yet, and this is because the impact of the Russia-Ukraine conflict and sanctions on Russia by the U.S. and its allies still have their role to play. The Fed made it clear last night that they do not fully understand the influence of this conflict on inflation. Another wild card for inflation is the commodity crisis, as oil prices seem to have peaked already.

To conclude, I believe that traders are less fearful about the Fed's monetary policy, which was keeping them on the sidelines. Given that we know that the Fed isn't going to be overly aggressive and inflation may have peaked already or near those levels, it makes the U.S. stock market even more attractive among investors who favor riskier assets.

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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