Fed sees terminal rate at 5.1%: what to expect from S&P 500 in 2023?

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on Dec 14, 2022
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  • U.S. Federal Reserve raises interest rates by another 50 bps.
  • The FOMC now forecasts the terminal rate at 5.1% in 2023.
  • Fundstrat's Tom Lee reveals his next year's target for S&P 500.

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The U.S. Federal Reserve just delivered its well-telegraphed 50 basis points increase in interest rates – a day after the consumer prices were reported to have eased further to 7.1% in November (read more).

What’s the updated projection for terminal rate?

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That pushed the key rate up to 4.25% to 4.50% – a range that was last seen about 15 years ago.

S&P 500 gave back its intraday gain following the announcement particularly since the central bank is now projecting a terminal rate of 5.1% in 2023. The FOMC statement remained almost unchanged from last month.

According to the Federal Open Market Committee, the U.S. economy is expected to grow at an annualised pace of 0.5% this year. That’s a significant leg down versus the rapid growth a year ago.

Nonetheless, Chair Jerome Powell reiterated that the labour market remains strong, and the rates will have to remain higher for longer to win the ongoing battle against inflation. Despite two consecutive months of soft readings, he says the Fed needs substantially more evidence that inflation is trending down in a sustainable manner.

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What also ticked off investors was that the FOMC lifted its forecast for the “Core PCE Price Index” – its preferred inflation gauge by 30 basis points versus the September projection to 4.8%.

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Participants continue to see risks to inflation as weighed to the upside.

Fundstrat’s Tom Lee expects stocks to rally in 2023

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Still, Fundstrat’s Tom Lee expects the S&P 500 to end next year at the 4,750 level, which suggests about a 20% upside from here. Defending his constructive view on CNBC’s “Halftime Report”, he said:

Monetary policy lag is true. Inflation has already fallen by half in just the past few months and is annualizing at 4.0%. This is before we’ve really seen the bite of the monetary hikes.

Lee is convinced that the “earnings recession” will not play out as supply constraints continue to ease and currency headwinds soften. Interestingly, though, he’s not counting on positive earnings growth for that double-digit gain in the first place.

Out of 21 instances when stock declined in a year, the following year, 18 times were positive years, seven of those had negative earnings growth. So, stocks can do quite well next year as long as this crisis on inflation is ending.

Lee is bullish on the equities market also because oil – a key component of inflation has now returned to its price before the Ukraine war.

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