The Resilience Test: Can Stocks Weather the Fed's Next Moves?

With inflation stubbornly high and central bank policy pivoting, a pressing question looms: How much tightening can the stock market truly handle? Lori Calvasina, head of US equity strategy at RBC Capital Markets, offers a framework that strikes a cautiously optimistic note.

"Moderate" Is the Magic Word

Calvasina's thesis hinges on a simple distinction. It's not rate hikes themselves that threaten markets, but rather the pace and intensity of the tightening cycle.

"If we're looking at something like two 25-basis-point hikes over the next twelve months, I think the market would ultimately be okay," she noted recently. "The market seems to be able to handle anything that's done in a moderate fashion."

This provides a tangible stress-test scenario for investors: approximately two gentle hikes represent a digestible threshold. It implies that current market pricing may already be baking in such a measured approach.

The Market's Contradictory Signal: Rallying Amid Hawkishness

Interestingly, market action appears to echo this "moderate tolerance" theory.

  • Sustained Gains: Despite a surprisingly hawkish tone from the Fed last week, US stocks managed to post gains in a holiday-shortened week. This marked their eleventh weekly advance in the past twelve.
  • Sharp Rebound: The S&P 500 has rallied roughly 18% from its low hit on March 30, staging a significant recovery.

This divergence—hawkish policy coinciding with market strength—suggests investors are balancing two narratives: the Fed's resolve to fight inflation against the potential for corporate earnings resilience and an economic soft landing.

What to Watch Next

Calvasina's analysis shifts the focus from "if" to "how." For market participants, key variables now include:

1. The Inflation Path: Any signs of peaking or decelerating inflation could give the Fed room to maintain a moderate pace.

2. Economic Data Stamina: The strength of employment and consumer spending will test confidence in the economy's ability to absorb higher rates.

In the end, the stock market's path through this cycle will depend not just on the number of Fed hikes, but on the underlying health of the economy under rising rates. For now, the market is betting on that resilience.