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Stock market should 'right size' expectations for Fed pause, strategist says

More interest rate hikes remain on the table for the Federal Reserve. But that's not priced into the stock market, according to Oppenheimer's chief investment strategist John Stoltzfus.

"We persist in suggesting that investors curb their enthusiasm for a long rate pause or even a rate cut and instead right size expectations," Stoltzfus wrote in a note to clients on Monday.

Stoltzfus made no mention of moving down his year-end target for the S&P 500 of 4,900 but notes inflation is still too far off the Fed's 2% goal. Expectations are for the latest Consumer Prices Index reading on Wednesday morning to show prices rose 3.6% over the prior year in August, an increase from the 3.2% rise seen in July.

On a "core" basis, which strips out the volatile food and energy categories, CPI is expected to rise 4.3% over last year in August, a slowdown from the 4.7% increase seen in July.

"In our view even as the Fed appears to be nearing an end to the current rate hike cycle the stickiness evidenced in food, services, energy and other prices warrants the Fed remaining vigilant along with a potential for one more hike this year and perhaps another next year," Stoltzfus wrote.

As of Monday morning, markets had priced in a 93% chance the Fed holds interest rates steady at the conclusion of its Sept. 19-20 meeting, according to data from the CME Group. When looking ahead further, markets are pricing in 50%-plus probabilities that rates remain unchanged through the end of 2023.

Wednesday's CPI report will be the last inflation data for the Federal Reserve ahead of its meeting next week.

"With progress on inflation still tentative, the labor market cooling only gradually, and GDP continuing to chug along, we expect the post-meeting statement will continue to signal that the Committee maintains a hawkish bias," Wells Fargo chief economist Jay Bryson wrote in a note to clients on Monday. "Specifically, the statement likely will note considerations for 'additional policy firming' rather than hint at an extended pause in order to maintain optionality at its following meeting on November 1."

US Federal Reserve Chairman Jerome Powell speaks during a news conference after the release of the Fed policy decision to keep interest rates unchanged, at the Federal Reserve in Washington, U.S,  June 14, 2023.  REUTERS/Kevin Lamarque
US Federal Reserve Chairman Jerome Powell speaks during a news conference after the release of the Fed policy decision to keep interest rates unchanged, at the Federal Reserve in Washington, June 14, 2023. (Kevin Lamarque/REUTERS) (Kevin Lamarque / reuters)

One of the key categories holding up inflation is energy prices. West Texas Intermediate (CL=F) and Brent crude futures (BZ=F) have rallied more than 25% since late June, sending gasoline prices higher and threatening further price pressures to industries highly exposed to fuel costs.

This, however, could provide a buying opportunity in the stock market, per Stoltzfus and his team at Oppenheimer. To this point, oil's surge hasn't been reflected in energy sector exchange-traded funds.

"We find the S&P 500 energy sector looking increasingly attractive as policy makers in the US and abroad strive to contain inflation and manage economic growth," Stoltzfus wrote.

Oppenheimer also sees energy benefitting as stateside infrastructure projects and chip manufacturing efforts will help boost the sector.

Josh Schafer is a reporter for Yahoo Finance.

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