A slowdown in the pace of rate hikes by the US Fed has failed to cheer the markets in December so far. Although a 50 basis point rate hike in December was accounted for long back, US stock market investors were expecting a year-end Santa Claus rally.
However, December stock market performance to date has been lackluster and 2022 may end with the leading indices showing no signs of strength moving into 2023. One of the primary reasons attributed to this is the Fed officials’ statements pointing towards more rate hikes next year with a rate-cut scenario sometime in 2024. This means Fed rate hikes may continue in 2023 although the pace of interest rate increases may slow down. Investors are still on the edge after recent remarks from the Fed and other hawkish central banks across the globe. Risk assets have taken a hit since US policymakers last week signalled a peak rate between 5.1% and 5.25%, which is way above market expectations.
Going forward, the rate hike is expected to be 25 basis points until more economic data emerges. Continued rate hikes impact the economy as borrowing costs for individuals and businesses rise. Eventually, consumer demand falls, and corporate balance sheets and earnings get impacted negatively.
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“Fed forecasts suggested the central bank would hold rates at their peak until 2024, rattling some investors who had expected officials to begin cutting rates next year. Private-sector bottom lines are suffering from weak consumer demand. While inflation is cooling, higher input and borrowing costs are weighing on both businesses and households. Excluding the Covid-19 downturn, this is the quickest softening in business activity since 2009,” says Mitul Shah, Head of Research – Institutional Desk, Reliance Securities.
The fate of the US economy will decide the next course of action for the stock market investors. Earnings and management outlook of their own industry amidst deteriorating macroeconomic factors will also play a role in market sentiment.
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The stock market is drifting downwards in December because investors now fear recession more than inflation. The uncertain near-term outlook for the US economy has increased market volatility, as recession fears weigh on company earnings expectations.
But, here’s a silver lining to the market sentiments. According to a report by LPL Financial, the Santa Clause Rally, a seven-day period at the end of December and beginning of January, has historically delivered stock market gains comparable to a strong month. S&P 500 has generated average returns of more than 1.5% in December since 1950. It remains to be seen if history repeats itself.