Bah humbug! Federal Reserve tries to ruin chance of Santa rally

The decision on US interest rates was predictable but comments from policymakers have made it hard work for stock markets.

Fears that markets have gone “too far too fast” during their strong end to 2022 were raised today after the Federal Reserve signalled much more work is needed to tame inflation.

Guidance from the US central bank pointing to interest rates still above 5% next year sent a chill through global shares, having rallied sharply since mid-October on hopes that US monetary policy is close to its peak.

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UBS Global Wealth Management told clients this morning that a recent 12% rise for the S&P 500 index failed to reflect the potential impact of earlier severe US rate rises.

Chief investment officer Mark Haefele said: “In our view, markets have moved too far too fast to price an end to the rate-hiking cycle. We do not see this as fully reflecting the drag on growth imposed by prior tightening.

“This slowdown will take a toll on S&P 500 earnings, which we expect to contract by 4% in 2023. Bottom-up consensus earnings growth expectations are currently 5%, which may be too optimistic.”

This echoed the more cautious stance of the Federal Reserve, whose projections showed a revised 2023 US growth estimate of 0.5% compared with September’s 1.2%. The estimate for the unemployment rate is almost a percentage higher at 4.6%.

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Haefele said the hawkish tone from the Fed underlines his bank’s view that the conditions are not yet in place for a sustained rally, prompting his recommendation that investors take a defensive stance when adding exposure.

He added: “In equities, we favour healthcare and consumer staples - sectors that are less vulnerable to the economic slowdown.

“Regionally, we like the cheaper and value-oriented UK and Australian equity markets relative to US equities, which have a higher exposure to technology and growth stocks, and where valuations are higher.”

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Last night’s decision delivered the expected 0.5% rise in the Fed funds rate to 4.25%-4.5%, with all but two of the 19 participants expecting the target range to rise to over 5% next year.

Wall Street is currently looking for the Fed’s next meeting to deliver a quarter-point increase, with a terminal rate of 4.87% still well below the central bank’s guidance.

Federal Reserve chair Jerome Powell made it clear the bank has “some ways to go” before it can declare victory in the fight against price pressures.

The US consumer prices index is down to 7.1% from June’s peak of 9.1%, but the Fed’s preferred inflation measure of personal consumption expenditure shows a higher-than-expected figure of 3.5% by the end of 2023.