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  • The Federal Reserve raised interest rates by 0.50% today.
  • The increase was smaller than previous increases this year; however, inflation measures remain troublesome.
  • Fed officials' comments could dictate what's next for stocks in the coming days.

The Federal Reserve’s laser-focused on keeping inflation in check. Unfortunately, the Central Bank is like an outspoken bore who arrives late and stays long past when the party is over. Lagging data means it eases and tightens too much, and it’s unlikely to be different this time.

This week’s November Consumer Price Index (CPI) data showed inflation – for a second consecutive month – decelerated faster than analyst expectations. Headline CPI at 7.1% was below the 7.3% anticipated and October’s 7.7% level. Excluding gas and food (silly, I know!), the closely watched core CPI of 6% was below 6.1% expectations and October’s 6.3% level.

Of course, the Fed’s preferred inflation measure is the Personal Consumption Expenditures (PCE) Index, not CPI. But its story isn’t very different.

The headline and core PCE were up 6% and 5% from one year ago in October (the most recently reported month), below peak levels yet still far above the Central Bank’s target.

Progress? Yes. But the Federal Reserve’s decision to boost rates by another 0.50% today reminds us that we’re still miles north of its 2% inflation target.  

The increase brought the Fed Funds rate to a 4.25% to 4.50% range. The Fed's dot plot, a chart showing each member's expectation for future rates, revealed officials expect rates to peak at 5.1%. In September, the dot plot suggested rates would finish 2023 at 4.6%.

Moreover, high inflation continues to outpace wage growth, so negative real income remains a drag on the economy.

A Fed Pivot? Forget about it

If a pivot is a pause, then OK, we’re heading towards it. However, a true pivot would be a shift from hikes to cuts, and that’s not on the table yet.

In “Hey, Traders, Get It in Your Head That the Fed Isn't Pivoting, OK?,” Real Money Pro’s Maleeha Bengali writes:

“Now that the rate of increase in CPI is lower, the market is taking solace in the view that the Fed may be done tightening as the phrase "Fed pivot" is heard across trading floors…The reality is the Fed is nowhere close to pivoting if a Fed pivot means a U-turn from tightening to cutting rates.

Historically that has never happened, as even in 2001 when the Fed cut rates, the markets fell another 10%-plus. It is ironic that the market is cheering when inflation is still averaging around 7%. We are past peak inflation as we have seen an outright collapse in global supply tightness in freight and demand, and inflation may be slowing, but to do a victory lap calling an end to inflation altogether is a bit presumptuous.”

Presumptuous, indeed.

Inflation is yet to be wrestled to the floor, so until that happens, Marty Zweig’s “Don’t fight the Fed” mantra should still be ringing in investors’ ears. As Zweig noted in his excellent book, Winning on Wall Street, stocks struggle when the Fed’s quest for price stability makes market conditions “extremely bearish,” like now. The pathway to stock market profits won't be more easily traveled until the Fed starts easing rates.

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A strong labor market is one big reason the Fed may overstay its welcome by raising interest rates more than necessary.

We’re seeing signs of decelerating job growth, given the economy is creating fewer jobs on a rolling 3-month basis than it was previously. Nevertheless, a 3.7% unemployment rate remains historically low, and open jobs suggest wages still underpin inflation. Admittedly, employment is a lagging indicator, but that doesn’t change the fact that it’s still a worrisome input into federal reserve officials' policy calculus.

Real Money’s James DePorre writes:

“The labor market remains a big problem. Labor is the biggest component and is almost half of PCE inflation. The problem the Fed faces is that the demand for labor far exceeds the supply, which is driving wage inflation. The only way the Fed can deal with wage inflation is by slowing economic growth and killing demand for more employees…the labor issue is why the Fed is likely to stay hawkish and will not declare victory over inflation any time soon.”

The Smart Play

How stocks react to Fedspeak is most important, so it will be key to see if sellers re-emerge when central bank members do their media rounds in the coming week.

Stocks may benefit from mid-month fund flows, but end-of-year tax-loss selling poses a stiff headwind. Historically, it pays to sell the first half and buy the second half of a bear market. But, unfortunately, nobody blows a whistle, signaling halftime.

Stocks have rallied since mid-October, but they’re hitting resistance, and worries the Fed will hike us into a recession are mounting. Moreover, the bear market has shifted speculation from “buy-the-dip” to “sell-the-rip,” so short covering that may have supported stocks this week could fade in keeping with “buy the rumor, sell the news” now that the Fed’s meeting is over.

Given the uncertainty, active investors should stick with their defensive playbook a little longer. Continue building a watch list to identify leaders, but buy smaller-than-usual positions, hold higher-than-usual levels of cash, and protect positions with stop losses.

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