All eyes on the Fed The central bank meets Tuesday to talk interest rates and for the first time in two years, there may not be a hike. NEW YORK (CNNMoney.com) -- Stock investors return to work this week with the knowledge that they are probably going to get exactly what they have been wanting for months. And that perhaps they should have been a little bit more clear in their request. The Federal Reserve board meets Tuesday to discuss interest-rate policy and for the first time in more than two years, there may not be a rate hike. It's a scenario that Wall Street bulls have been looking forward to for months, while sitting through 17 straight interest-rate hikes that took a key short-term lending rate from 1 percent to 5.25 percent. But now that the much longed-for event is actually nearing, investors don't seem quite as happy about it as might have been expected, and that could set up a potentially tough week and month ahead for stocks. "The market is a never-ending battle between short-term wants and long-term needs," said Barry Ritholtz, chief investment officer at Ritholtz Capital Partners. "Short-term, everyone is thrilled if the Fed is done," he added, "But long-term, if the Fed is stopping because the economy is slowing, then that's not good." That conflict certainly was evident Friday, when a weak July jobs report became the latest data to suggest the economy is slowing enough for the Fed to take a pause. Next week also brings a smattering of July economic news and earnings from Walt Disney and a few other marquee names. But the focus will undoubtedly be the Fed's decision and what it says in the statement about the economy and the direction of interest-rate policy going forward. To pause or not to pause? Prior to Friday, traders had been on the fence about whether the Fed was likely to raise or pause at the Aug. 8 meeting, according to fed funds futures traded in Chicago. On one hand the economy seemed to be slowing - weak reads on retail sales, housing and second-quarter GDP growth made that clear. Plus, Fed officials had said as much. But that didn't necessarily have to mean that the Fed was gearing up to pause. Then the July jobs report was released Friday morning and all that changed. The report showed smaller-than-expected job growth and a bigger-than-expected rise in unemployment - the last link in the economic slowdown chain. Yippee! Stocks rallied; bonds surged; bets for a rate hike Tuesday dwindled down to 16 percent from 41 percent the previous day, according to Chicago futures trading. And within an hour the rally was gone. "The market seemed to realize almost immediately that the Fed pausing now because it is worried about economic growth is not a good thing for stocks," said Ken Tower, chief market strategist at CyberTrader. "Weaker economic growth means weaker profits." Granted, the Fed could surprise investors and raise rates one more time Tuesday, but that doesn't seem likely. "There is enough evidence to suggest that the Fed can sit on its hands for another six weeks and see how it goes," said Stephen Stanley, chief economist at RBS Capital. Stanley was referring to the fact that the next Fed policy meeting after Tuesday's is not until Sept. 20th. However, pause or no pause, "the whole notion that a pause in rate hikes is always good for stocks is ridiculous," said Michael Darda, chief economist at MKM Partners. Ritholtz Capital Partners' Barry Ritholtz pointed out that historically, stocks only rise on average in the immediate aftermath of a Fed pausing. More often than not, the S&P 500 is lower six or 12 months after the pause. MKM's Darda said that stock investors tend to think an end to rate hikes is a positive because they worry that the Fed will tighten monetary policy too much and send the economy into a recession. Such a scenario would also crimp corporate profits, and raise price-to-earnings ratios, making stocks more expensive relative to earnings. However, he said that there is little reason to assume that a recession is on the way, with the only troubling sign being the inversion of the yield curve - a bond market aberration that has often predated recessions. In addition, there is no reason to suggest that should the Fed pause next week, they won't resume lifting rates in the fall. Darda said that he thinks the economy will show greater strength in the fall, which could lead to a need for more rate hikes. Additionally, all the analysts said that they were worried that rising inflation would force more rate hikes going forward, a scenario even more troubling for stocks. Next week's key events
What to expect at the Fed meeting |
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