Hopes for Fed Pivot Have Faded, Sapping Stocks’ Momentum

Not long ago, many investors thought the Federal Reserve would cut interest rates next year. Now, few do.

The shift in thinking around the Fed’s policy direction, spurred by Fed Chairman

Jerome Powell’s

speech in Jackson Hole, Wyo., last week, is taking the steam out of the summer rally that had helped stocks, bonds and cryptocurrencies bounce back from their lows.


Do you think the Fed can pull off a soft landing and avoid a recession? Join the conversation below.

U.S. stocks have fallen every day since Mr. Powell stressed that the central bank must keep raising interest rates and then hold them at high levels to fight inflation, even if it hurts economic growth. It marks a shift from earlier in the summer, when investors bet that inflation had peaked and that the central bank would be able to pull off a soft landing, a scenario in which it slows down the economy without causing a prolonged or deep recession. 

To be sure, few believe a protracted downturn is imminent. Consumer spending has remained resilient despite inflation pushing prices higher. The labor market also still looks robust. But money managers say a scenario in which the Fed avoids causing a recession altogether looks increasingly unlikely, given the central bank is determined not to repeat its mistake from the 1970s of prematurely easing monetary policy. 

Federal Reserve Chairman Jerome Powell said the central bank must continue raising rates until it is confident inflation is under control. He spoke at the Kansas City Fed’s annual symposium in Wyoming. Photo: Jim Urquhart/Reuters

Even without a recession, investors see the potential for pain ahead: Further interest-rate increases threaten to put more pressure on expensive parts of the stock market, which were among the biggest gainers in the summer rally. Meme stocks, shares tied to cryptocurrencies and technology stocks have slumped in the past week. 

“With each interest rate hike, the ability to stick that landing and make everyone happy…that’s getting more and more difficult to do,” said Rod von Lipsey, a managing director at


Private Wealth Management. UBS strategists now see a 60% chance of the economy entering a recession sometime in the next year, up from 40% in June.

The possibility of recession has made it difficult for investors to be optimistic about markets’ path in the coming months. Economic downturns have historically been bad news for stocks: The S&P 500 has fallen a median of 24% in recessions going back to 1946, according to Deutsche Bank.

With the S&P 500 currently down 17% for the year, stocks appear to have already priced in a mild recession—but not a deep one, said

Brent Schutte,

chief investment officer of Northwestern Mutual Wealth Management Co. 

The general unease among investors raises the stakes ahead of Friday’s jobs report. Economists surveyed by The Wall Street Journal are expecting the Labor Department’s data to show employers added 318,000 jobs in August while the unemployment rate stayed at 3.5%, matching February 2020’s half-century low.

A strong report could give the Fed more resolve to keep raising interest rates, since so far, the labor market has remained tight despite rates going up. What about a weak report?

For much of the decade following the 2007-08 financial crisis, investors cited the mantra that bad economic news could be good news for markets, since it should push the Fed to delay or scale back plans for its interest-rate increases. This time around, some investors say the dynamic looks different. Bad economic news could be simply that: bad news all around.

“The challenge for the markets is, even if the Fed thinks the economy is slowing, that inflation is slowing…they’re not going to talk differently until they’re thoroughly convinced that inflation is tamed,” said

Keith Lerner,

co-chief investment officer of Truist Advisory Services.

That means for the markets, “a little bit of bad news could go a long way,” Mr. Lerner said.

At least one report has already shown some signs of cooling in the labor market.

Data released Wednesday by payroll processor ADP showed private employers added 132,000 jobs in August, far less than the 300,000 economists surveyed by the Journal had expected to see. 

“I wouldn’t be surprised if Friday’s report was a big disappointment,” Mr. Schutte said. 

Federal-funds futures show the market pricing in a 69% chance of the Fed raising interest rates by 0.75 percentage point in September, according to CME Group’s FedWatch tool. That is up significantly from one month ago, when market expectations for a rate increase of that size stood at 28%. 

The Fed has clearly communicated that it will have to be aggressive in raising interest rates to get inflation under control, even if that winds up causing a recession, said Mr. von Lipsey of UBS. 

“The medicine to cure the illness of inflation will be the cause of a recession. Investors are debating what’s worse, the illness or the cure,” he said.

Write to Akane Otani at akane.otani@wsj.com

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