Jerome Powell snuffs out another bear market rally

The second week of October’s big events will have a market impact in due course. But for now, the Federal Reserve (Fed) remains in the driving seat.

What investors are watching

They say the definition of insanity is doing the same thing and expecting a different outcome. That’s not a bad description of the market’s repeated over-optimism this year. Investors are on a loop, pinning their hopes on an easier Fed, only for chairman Jerome Powell to douse their expectations with a bucket of cold realism.

It happened in the summer when markets rallied in the belief that interest rates would peak sooner and lower than markets had priced. That false dawn ended at the Jackson Hole central bank summit in August when Mr Powell said he would raise rates higher and longer. Shares quickly retreated.

October saw exactly the same script play out, as investors bet this time that looming recession would lead to a lower peak than feared. Again, the Fed chair put them right in no uncertain terms. At last week’s rate-setting press conference - when interest rates rose by 0.75% for the fourth consecutive meeting - he said that rates would go higher and stay there for longer than the market expected. A second cold shower for investors and a second bear market rally hit the buffers.

And what they are not watching (but the rest of the world is)

We’ve got used to economic and market news topping the bulletins, but this week investors are likely to take a back seat. Both the big stories this week are important - and will in due course have a significant market impact - but maybe not just yet.

You can tell how the world’s priorities have changed over the past 12 months by comparing the media’s coverage of the run-up to COP26 in Glasgow last year and this year’s COP27 event in Sharm el Sheikh, Egypt. War and recession have pushed climate change onto the back burner but the window to prevent irreversible warming is a year closer to slamming shut so it’s never been clearer that the environment is the most important of environmental, social and corporate governance’s (ESG) three concerns.

The impact of this week’s second big event - America’s mid-terms - is also likely to be more significant in the long than the short term. What seems certain is that the Democrats will lose control of the House of Representatives and it’s possible that the Senate will go the way of the Republicans too. That potentially opens the door to a Donald Trump re-run in 2024 and could hasten the retirement of 79-year-old Joe Biden.

That would certainly be a big market development. But in the short-term the impact of the election is more likely to be political gridlock. A lame-duck President is not necessarily bad news for investors. In fact, the third year of the Presidential cycle is usually the best of the four. And that’s partly due to political inactivity sometimes being the best thing for the markets.