Stocks Keep Fighting a Hawkish Fed. Why That Has Worked.

Fed Chair Jerome Powell has struggled to tame inflation. That hasn’t affected stocks. (Chip Somodevilla/Getty Images)

A stock market shibboleth, that it is futile to “fight the Fed” and challenge the force of monetary policy, is losing its potency. Doing just that is now proving profitable.

Federal Reserve Chairman Jerome Powell reiterated his cautious stance on interest rates Wednesday, following a fifth consecutive meeting in which the central bank made no changes to its benchmark borrowing rate. His postmeeting press conference was hawkish: Not only did he not signal near-term rate cuts, he also suggested rates could rise as he and his colleagues weigh how tariffs are affecting the price of goods.

Yet that failed to dent the stock market’s broader rally. In fact, according to data from veteran Wall Street strategist Jim Paulsen, the current bull market, which began during the depths of the pandemic in late 2020, is the first in six decades to power through hawkish Fed policies and an unfavorable economy.

Paulsen’s Total Policy Stimulus (TPS) index, which combines fiscal and monetary policies as well as the trade-weighted value of the dollar, is designed to calibrate whether U.S. economic policy is accommodative or contractionary, based on positive or negative readings respectively.

That index, he says, is now trading at levels seen prior to the global financial crisis in 2008 and below where it was prior to the pandemic of 2020. In both instances, when markets finally did turn sour, the selloffs were violent, with peak-to-trough declines of more than 40% in 2008 into 2009 and a slump of nearly 25% in the winter of 2020.

That isn’t happening now. Stocks reached record highs again in early Thursday trading, and the S&P 500 was on pace for a year-to-date gain of around 8.3% in afternoon trading. Track back to October 2020, and the index is up nearly 80%.

The issue is that the rally has been largely dominated by a handful of stocks. Nearly all of them are focused on artificial intelligence technologies, resulting in one of the “narrowest” rallies, in terms of overall stock participation, on record.

“The contemporary bull market is the only bull run since 1960 which has lived its entire existence under a contractionary TPS regime,” Paulsen said in a note published Thursday. “Contractionary TPS regimes have historically been associated with tech/growth leadership and by chronic underperformances by broader market plays like the equal-weighted S&P 500 index and small-cap stocks.”

Paulsen argues that early Fed rate cuts would not only reduce the risk of a near-term recession, but also “represent a game-changer for this bull market as it nears its fourth birthday.”

Powell, who isn’t concerned with how the stock market performs, is also not convinced that rate cuts are necessary either.

“It seems to me and to almost the whole [rate setting committee] that the economy isn’t performing as though restrictive policy is holding it back inappropriately and modestly restrictive policy seems appropriate ,” he told reporters in Washington on Wednesday.

“We’re well positioned to learn more about the likely course of the economy and the evolving balance of risks before adjusting our policy stance,” he said.

Investors are getting the message that rates aren’t heading lower soon. And a hotter-than-expected June reading for the personal consumption expenditures price index, the Fed’s preferred inflation gauge, appears to have crystallized it.

The CME Group’s FedWatch Tool suggests the odds of a September rate cut have slumped from 75% last month to around 37% in late Thursday trading.

But Jonas Goltermann, deputy chief markets economist at Capital Economics, said he doubts that a more hawkish Fed will be much of a challenge for stocks.

“In large part, that is on account of the rise and rise of the U.S. tech sector amid the boom in AI investment, which is seen as a secular trend that outweighs most smaller shifts in the cyclical outlook,” he said. “Our sense is that between a resilient U.S. economy and strengthening AI enthusiasm, the equity market surge may well extend faster than we have factored into our forecasts.”

That view was echoed by Bret Kenwell, U.S. investment analyst at eToro, in a note published Thursday.

“Markets have persevered through elevated interest rates for several years now,” he said. “Rate cuts are nice, but they aren’t necessary for U.S. stocks to continue higher.”

“Instead, earnings continue to drive the narrative— and today that narrative is focused on Microsoft and Meta’s results —while forward expectations for S&P 500 earnings are back to record highs,” he said.

Write to Martin Baccardax at martin.baccardax@barrons.com