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The Federal Reserve and the stock market are scattered over the central bank’s efforts to fight inflation.

Stocks capped a sharp two-day sell-off on Friday, erasing gains from a rally earlier in the week fueled by upbeat economic news. Inflation, as measured by the consumer price index, fell for a fifth straight month and by much more than analysts expected, according to data released just before the Fed is due to slow its rate hikes.

Although the Fed ended up raising rates by a smaller amount than its previous four hikes, the dovish forecast from officials, including Chairman Jerome Powell, shook markets out of their optimism. Instead of signs of lower interest rates ahead, the Fed warned that rates will be higher and stay that way for longer.

The Dow Jones Industrial Average fell 281 points on Friday, down 0.9 percent for a second straight week of losses. The S&P 500 closed 1.1 percent lower and the Nasdaq closed down 1 percent for the day, respectively.

“The Fed and the Stock Market Are Struggling. They’re in a fight right now,” Callie Cox, a U.S. investment analyst at online investment firm eToro, said in a phone interview on Friday.

“The stock market has been in a tailspin for months now, really since the summer, and the Fed has been telling us over and over again that they are serious about inflation, they want to control inflation, and if that means keeping interest rates down. for a while high, so be it,” he added.

As interest rates continue to rise, businesses will face steeper borrowing costs and have less money to invest in expansion, making their stocks less attractive to investors. Households will also have less disposable income to throw at the market as interest rates on their mortgages, car payments and credit cards rise.

Stock market woes, however, are an important part of the Fed’s plan.

Fed officials know their tough talk about keeping interest rates high and reining in inflation at any cost to worry investors and traders. Those warnings are meant to temper Americans’ expectations and make businesses feel the pinch from higher interest rates without rising stock prices to cushion the blow.

“The Fed knows its words are just as powerful in a world where social media is so pervasive and information just moves so fast,” Cox said. “The Fed prepares markets for what’s coming before it actually happens. This time, though, it just looks a little more painful because the Fed needs to lower inflation.”

Powell said at a press conference Wednesday that the U.S. still has “a long way to go” before a sustainable rate of inflation falls. He added that the only way for the Fed to achieve that goal is to keep its foot on the economy’s brakes with higher interest rates designed to raise the unemployment rate.

November’s unemployment rate of 3.7 percent was just 0.2 percentage points below its level in February 2020, then a five-decade record low. But the U.S. labor force now has roughly 4 million fewer workers than it did before the pandemic began, while businesses are posting record job openings.

With fewer workers available to fill job vacancies, businesses have been forced to raise wages to attract candidates and prices to compensate for the higher pay. That dynamic, Fed officials say, is why inflation has remained high even as prices for almost everything else except food have fallen.

“We have too many jobs and too few workers, so that means wage inflation will be far from a sustainable average, and we will have that pass through to prices. That’s what we’re working on right now,” Federal Reserve Bank of San Francisco President Mary Daly said at an event hosted by the American Enterprise Institute on Friday.

“To be honest with you, I don’t really know why the markets are so bullish on inflation,” Daly said.

Fed officials boosted their forecasts on Wednesday about how high they would need to raise interest rates and how long they would keep them to dampen the labor market.

They now expect to raise rates by the end of 2023 to a range of 5 to 5.25 percent, down from the 4.5 to 4.75 percent forecast in September, and they do not plan to cut rates until 2024.

The Fed also sees its rate hikes doing serious damage to the US economy, forecasting the unemployment rate to rise 0.9 percentage points to 4.6 percent by the end of 2023 and economic growth to slow to 0.5 percent : While Fed officials say that scenario could avoid major job losses, most outside economists believe that such a rise in the unemployment rate would mean more than 1 million Americans losing their jobs.

“The Fed has not welcomed the inflationary trends that have just begun to emerge and has focused on steady job gains and higher inflation. Any hope of a soft landing has vanished as the Fed appears committed to taking rates much higher,” Edward Moya, senior markets analyst at OANDA, said in a note to clients on Wednesday.

A Fed-induced recession or sharp slowdown would be worse news for the stock market as companies struggle with lower sales and fewer households have the flexibility to put money into risky assets. But higher interest rates themselves could be a bigger, longer-term drag on the stock market.

In the years following the Great Recession, stock prices exploded as the Fed kept its key interest rate range close to zero. The market’s stunning rally was accelerated during the COVID-19 pandemic, when low interest rates and trillions of dollars in federal stimulus helped all three major indexes to record highs.

With interest rates likely to stay high for much longer, Cox said the days of the market hitting record highs again are a long way off.

“When we look at 2023, we’re kind of seeing a year of purgatory,” he said.

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