DEUTSCHE BANK: We expect the stock market to do 1 of 3 things after the Fed speaks on Thursday

All eyes are on the Fed and its decision to raise interest rates or not this week.

Stock market investors and traders will surely be among those watching.

In a note to clients, US equity strategist David Bianco at Deutsche Bank laid out three possible scenarios and point targets for the S&P 500 based on what the Fed does.

  1. No hike: Rally to 2000-2050, struggle to hit 2100 by year-end. “We think the kneejerk reaction of the S&P to a no hike outcome would be to rally to 2000-2050 led by multinationals, exporters and even commodity producers. Banks would likely lag in this rally, but appreciate. We think such a rally fades in Oct as the next FOMC meetings approach and the S&P struggles to exceed 2100 by yearend”
  2. Hike, and vague on future hikes: Struggle to hit 2050 by year-end. “If the Fed hikes, we think the S&P can rally provided Treasury yields and the dollar don’t surge. Banks would likely outperform upon a hike. If the Fed hikes to 25bps or more and leaves its future plans for the next 6-9 months wide open and “data dependent” we think the market struggles to exceed 2050 by yearend.”
  3. Hike, but clear on slow increases in rates: 2150 by year-end. “However, if the Fed hikes and communicates firm guidance to not exceed 50bps until after mid 2016, in order to observe global conditions, we think the S&P rallies sharply to finish the year at 2150 led by Financials, Tech and Healthcare. A hike now with explicit guidance of hike limits through mid 2016 would be credible.”

The S&P 500 is currently trading near 1,950, implying that stock prices will go up regardless of what’s said.

For the analysts it really boils down to how clear the Fed is about their intentions in its statement. Any vagueness or indecision would be interpreted as weakness, and changes in the dot plot aren’t going to cut it.

“No hike, especially if not by December, will be seen as indecisive and cast doubt on any guidance issued as the risk of falling behind the curve rises if UE continues to fall,” Bianco said.

The analysts think that the best case scenario for the stock market is the Fed letting the economy build up strength slowly and organically.

“Promoting a long cycle should be the Fed’s focus and would be optimal for stocks,” they said. “Driving US GDP to 3% with monetary policy is not desired given labour market trends. If productivity delivers 3% growth then great, but not the Fed.”

The analysts do say that the underlying growth in the US economy is solid, with the labour market tightening and GDP growth slow but strong.

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