The Federal Reserve “Data-Dependent” Approach May Come Back To Bite
The Federal Reserve “Data-Dependent” Approach May Come Back To Bite

WISCONSIN ( — It is common in our financial industry each new year to review the past year, what happened with the stock market and our investments, and events that affected how we made money or lost it. 

In 2023, economists have a great disparity about what will happen with financial markets.

Because of stock market sell-offs in early 2022 and huge Federal Reserve interest rate increases, economists are split with analysis for this year. Some feel the US central bank is on track with a proper balance between rate increases while remaining “data dependent.”

The other half feel the Federal Reserve’s data-dependent approach is a recipe for disaster as inflation will continue to spiral.

Federal Reserve History Should Teach Us A Lot

GDP growth and inflation forecast. Credit: Global Data

In March 2021, inflation rose from the Federal Reserve’s 2% goal to over 4.5%. Each consecutive month after that, inflation kept climbing until it reached a daunting 7% by year’s end. Still, the Fed did nothing to express a belief that inflation would temporarily fade without intervention.

What resulted was a significant error by the Federal Reserve. Inflation was at its highest levels in four decades. So the Fed is making a mistake by waiting too long to stop rate increases.

Stock Market in 2023

Stock market volatility versus inflation rate. Credit: Glenmede
Stock market volatility versus inflation rate. Credit: Glenmede

Without being too dramatic, the stock market got shocked in 2022. Investors, in turn, heavily sold stocks. As a result, parts of the stock market lost over 70% of their value. Fundamentals may have been steady during this crisis, but the growth backdrop needs to be revised.

The labor market is contracting, so unemployment is expected to rise to 5%. Consumers have relied on their savings, but the cushion needs to improve. Businesses and consumers have learned the meaning of tighter budgets and cut optional spending habits.

The S&P 500 Index is expected to re-test last year’s lows as the Federal Reserve is over-tightening. Once interest rates level off, the Fed will watch inflation and employment. Eventually, there will be a pivot in policy, and stock markets should climb again, with the S&P 500 looking to reach over 4,200 by December 2023.

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