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Stock Market’s Newfound Optimism Faces Test as Fed Meets

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Wall Street has welcomed a change of tone in the beginning of 2023: Fears of a severe economic downturn are receding as slowing inflation raises hopes that the Federal Reserve will soon be done raising rates of interest.

In the primary 4 weeks of the yr, this optimism has resulted in a 6.2 percent jump within the S&P 500 and an excellent greater rally amongst big technology stocks. Tech stocks were among the many worst performers in 2022 due to their sensitivity to rising rates of interest, and their rally now’s helping to drive the broad market higher.

The gains have been led by a gradual flow of knowledge that shows the economy continues to grow, while inflationary pressure is easing. On Tuesday, for instance, a key measure of pay and advantages — the Employment Cost Index — rose lower than economists had expected, and the S&P 500 jumped 1.5 percent.

But this upbeat outlook faces an enormous test on Wednesday, with caution resulting in a 0.3 percent decline within the S&P 500 index in morning trading.

The Fed is widely expected to boost rates of interest by just 1 / 4 of a percentage point later within the day, the smallest jump since March. Higher rates of interest raise costs for firms and consumers, and weigh on profits and spending, so investors are welcoming the prospect that the central bank could begin to ease off.

In some quarters of the financial markets, the optimism has gone even further. Regardless that the Fed has signaled that it is going to raise its benchmark rate above 5 percent, a growing variety of investors are betting that the speed won’t ever get that prime.

That view has set the stage for a battle between the Fed and the financial markets.

The stock market gains — which enrich investors and make it easier for them to borrow — actually undercut the Fed’s efforts to slow the economy enough and pull down inflation. The last time stocks began to rise markedly, over the summer, the Fed’s chair, Jerome H. Powell, needed to publicly warn that the fight against inflation was removed from over. That was enough to send stock prices lower again.

Mr. Powell can have a probability to do that again on Wednesday when he speaks to the press after the Fed broadcasts its decision.

“Powell is predicted to be hawkish in his press conference to counteract the trends he still fears towards a resurgence of inflation,” noted Andrew Brenner, head of international fixed income at National Alliance Securities.

That might trigger a pullback available in the market — and if last summer’s slump is any guide, it could possibly be steep. Back then, after Mr. Powell warned investors during a late-August speech that the Fed’s effort to get inflation under control was “unconditional,” the S&P 500 fell 15 percent before the selling stopped in October.

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