US stock markets have been falling precipitously this year. The fall stems from concern over inflation fears and what the Federal Reserve System will do to quell inflation.
Inflation and Rates Affect the Stock Market
Inflation has been hot this year, and the Fed's only tool to reign in inflation is raising interest rates. Considering how high and fast inflation has been rising, investors believe that the Fed will have to raise interest rates aggressively.
There is a belief that the Fed may have to raise interest rates so aggressively that the economy will enter a recession. Raising interest rates makes loans expensive; through a chain reaction, it will lower business investment and consumer spending. Lower business investment and consumer spending lead to lower growth and demand, which leads to lower inflation.
Stocks Are in a Bear Market
Investment bankers are warning their clients that even though the selloff has been profound, the stock markets can go lower. The concern from institutional investors is that America may be on its way into a recession. Fears of a downturn are significant because while stocks are down 20 percent from their all-time highs, the drawdowns are only 60 percent compared to previous recessions. According to their estimates, if there is a recession, the S&P could fall to 3,000. Market weakness will be present till the recession arrives or the risk of one is eliminated.
The markets plunged into bear territory when the S&P fell to 3,749 in June, just before the Fed announced its most significant interest rate hike in 28 years. As investors expected, the Fed raised interest rates by 75 basis points after two rate rises this year, including a 50 basis point rise in May.
It was only in January when the markets were at all-time highs. The drop represented a 21 percent loss in value until June; markets are in a bear phase after losing 20 percent. The decline also put the markets at a lower level than in March 2021. The next three to six months will determine the severity of the recession risk. There is a small window for the Fed to maneuver its way out of a high inflation without wrecking the economy.
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