Federal Reserve Rate Hikes and Market Optimism: Are Investors Becoming Too Confident?

In the past year, the Federal Reserve has been rapidly increasing interest rates in order to cool the economy and curb inflation[1][0] Despite the warnings of experts and officials that the hikes could lead to an increase in unemployment, the Fed pushed its benchmark rate to a range of 4[1]5%-4[1]75% – the highest level in 15 years[1] However, the markets interpreted the FOMC statement and Fed Chair Powell’s press conference as being more dovish than expected[0][1] Powell noted that more rate hikes are required to make sure inflation continues to cool down[3][1]

The S&P 500 US share index and the Nasdaq Composite, which are weighted towards America’s tech giants, have both rallied since the start of the year[4][1] The S&P 500 has gained nearly 9% and the Nasdaq has gained more than 16%, and the VIX index, which tracks investor expectations of volatility, has been below its long-term average of 20 for two consecutive weeks – the longest stretch of low volatility since the beginning of last year[4][1]

Investors seem optimistic that if inflation is kept in check, the Federal Reserve’s interest rate increases could be coming to an end[2][1] The sudden improvement in the global economic outlook has bolstered the optimists’ argument and investors are becoming increasingly confident that the Fed can subdue inflation without causing a major recession[5][1]

The assets that suffered the most during last year’s market crash are currently the highest performing ones[5][1] The value of Bitcoin has risen by a staggering 40% and the ARK Innovation Fund managed by Cathy Wood, which is mostly comprised of tech stocks, has achieved an impressive 46% growth[5][1] Mike Lewis, head of U[1]S[1] equity cash trading at Barclays PLC, said: “People don’t want to miss a rally … you get a little bit of FOMO.[1]

Analysts and investors at large banks and asset managers such as Morgan Stanley, UBS Group AG and BlackRock Inc[1] have repeatedly argued that markets have been too optimistic, but stocks have so far largely shrugged off weak fourth-quarter corporate results[1]

Goldman Sachs’ David Kostin said: “Despite the recent rally, there are several reasons we believe upside to US equities remains limited and that the S&P 500 is unlikely to end the year substantially above our year-end target of 4000.[1].[1].[1]

0. “Dow Jones, Nasdaq, S&P 500 weekly preview: Stocks rally likely over – analysts” StreetInsider.com, 6 Feb. 2023, https://www.streetinsider.com/dr/news.php?id=21165055

1. “Fearing to miss the rally, investors are pushing stock markets up” Business Review, 6 Feb. 2023, https://business-review.eu/profiles1/opinions/fearing-to-miss-the-rally-investors-are-pushing-stock-markets-up-241238

2. “The Stock Market Is Rallying. Will It Last?” msnNOW, 8 Feb. 2023, https://www.msn.com/en-us/money/markets/the-stock-market-is-rallying-will-it-last/ar-AA17fyqW

3. “The Stock Market Is Off To A Great Start In 2023 — Here’s How The Federal Reserve, Interest Rates May Cha” Benzinga, 9 Feb. 2023, https://www.benzinga.com/analyst-ratings/analyst-color/23/02/30821783/the-stock-market-is-off-to-a-great-start-in-2023-heres-how-the-federal-reserve-inte

4. “Investors pile into market rally as economic slowdown risk ebbs” Financial Times, 5 Feb. 2023, https://www.ft.com/content/53b883de-decf-4d84-bb5e-661bb855b1fd

5. “FOMO fuels market rally as investors assess risks of a recession are receding” Financial Post, 6 Feb. 2023, https://financialpost.com/investing/fomo-fuels-market-rally-investors-recession