Inflation and the Federal Reserve are the two things dominating the stock market these days.
And how, more specifically, do inflation and the Federal Reserve affect the stock market?
Well, on the one hand, they generate a major swing in volatility.
Since August 1, 2022, the CBOE’s VIX volatility index has shown a sharp rise.
In early August, the VIX index was hovering around 20.0.
According to new information, the inflation rate remained high and was not going to come down immediately, as many investors thought.
If inflation showed signs of easing, many investors believed the Federal Reserve would abandon the “strong” stance it had promoted.
If the Fed pivots, stock prices should go up, right?
Thus, the market began to show larger swings as stock prices rose on any news that inflation might decline, meaning the Fed might “return” to its quantitative tightening.
But, as soon as Federal Reserve officials stepped in and said the Fed was not going to “back off,” stock prices fell sharply again.
Any other information played only a minor role in the volatility of the stock market, as this information was only seen as adding to investors’ attention to whether the Fed would “pivot” or not.
Latest inflation news
The latest wave of market volatility came last week.
The news that sparked the move was that the consumer price index (CPI) for August came in, year-over-year, at 8.2%.
This was down from 8.3% the previous month, but the index was expected to fall to 8.1%.
The core inflation rate increased, year over year, to 6.6% in August. It was a forty-year high.
Funny thing. The stock market first rose.
Isabella Simonetti and Joe Rennison comment on this in The New York Times:
“In a see-saw move that mirrored Thursday’s sharp turn from a loss to a gain, the S&P 500 fell 2.4% on Friday, after rising more than 1% in the morning. left the index down 1.5% for the week, erasing last week’s gain.The benchmark index is down more than 25% since January.
But, the balance sheet established at the end of the week:
The likelihood had increased that the Federal Reserve would raise its key interest rate by another 75 basis points when the Federal Open Market Committee meets on November 1-2.
By the way, Simonetti and Rennison ignore the fact that early earnings reports from the nation’s largest banks showed weaker profits.
I guess that information was not that important.
The Federal Reserve is on the right track
But the Federal Reserve is continuing its quantitative tightening trajectory, as I reported in my last piece on the Federal Reserve Watch.
Since March 16, the Federal Reserve has reduced the amount of securities on its balance sheet by approximately $190.0 billion. Its plan is to continue to reduce the amount of securities purchased by approximately $95.0 billion each month through 2024.
For now, the latest inflation figures released last week will support Fed officials who are talking about the continuation of the quantitative tightening program.
As a result, the underlying trend in stock prices should continue to be downward.
But the higher level of volatility will not go away.
There is so much uncertainty in the world today that there will still be plenty of investors on both sides of the market. So we will have volatility.
And, I don’t see the radical uncertainty that exists today going away anytime soon.
So, the forecast: stock prices will continue to fall in a very volatile environment.