The Fed’s Communication, Not Policy Decision, Will Define Market Expectations Going Forward: JPMorgan

According to JPMorgan's trading desk, the Federal Reserve's communication strategy could determine whether stocks rally or suffer another sell-off as investors navigate inflation concerns, rising Treasury yields and uncertainty over future monetary policy.

The Fed is widely expected to raise interest rates Wednesday, marking a significant shift from expectations just weeks ago when many investors believed the central bank would remain on hold. Fed funds futures were pricing in about a 93% probability of a quarter-point rate increase, compared with only a 33% chance one month earlier, according to the CME FedWatch Tool.

The change in expectations comes as inflation data has remained stubbornly high while energy prices have climbed amid ongoing geopolitical tensions. Rising oil prices have fueled concerns that inflation could remain elevated for longer, putting additional pressure on the bond market and pushing Treasury yields higher.

The impact has already been felt across financial markets. Major U.S. stock indexes declined for a second consecutive session Tuesday as investors reacted to rising bond yields. The benchmark 10-year Treasury yield climbed to its highest level since 2007, increasing concerns that higher borrowing costs could weigh on economic growth and corporate earnings.

JPMorgan analysts believe the Fed's decision itself may not be the only factor driving markets. Instead, investors will focus heavily on the guidance provided by Fed Chair Kevin Warsh during his post-meeting press conference and whether policymakers signal a more aggressive path ahead.

The bank outlined five potential scenarios and how each could affect the S&P 500.
In the first scenario, the Fed does not raise rates. JPMorgan believes that outcome could hurt stocks because investors may interpret the decision as a sign that inflation risks are rising and the Fed is not addressing them. A pause could push longer-term bond yields higher as markets adjust inflation expectations. Under this scenario, the S&P 500 could fall between 1.25% and 1.75%.

The second scenario involves the Fed delivering the expected 25-basis-point rate hike without offering additional guidance. JPMorgan considers this the consensus outcome among investors. A quarter-point increase could help stabilize the longer end of the yield curve while reassuring markets that policymakers are responding to inflation pressures. In that case, the S&P 500 could gain between 0.25% and 0.75%.

A third possibility could produce an even stronger market response. A quarter-point hike combined with a signal that the Fed could reverse some of its expected 2025 rate cuts. If Warsh indicates that future rate increases could come sooner, investors may view the move as decisive action against inflation. JPMorgan estimates the S&P 500 could rise between 0.50% and 1%.

However, the market reaction could turn negative if the Fed introduces concerns about the so-called R-star rate, the theoretical neutral interest rate that balances the central bank's goals of maximum employment and stable inflation.

If investors believe the current policy rate remains too accommodative and that the Fed may need to raise rates significantly higher, fears of additional aggressive tightening could return. JPMorgan estimates the S&P 500 could decline between 0.25% and 1% under that scenario.

The most negative outcome for stocks would be a message suggesting that interest rates need to remain "materially higher" to defeat inflation. Such guidance could remind investors of the aggressive rate-hiking cycle of 2022 and 2023, when the Fed rapidly increased borrowing costs to bring inflation down. JPMorgan estimates that scenario could trigger a 1% to 2% decline in the S&P 500 and potentially threaten the current market rally.