Wharton professor Jeremy Siegel warns the Dow could drop 1,000 points ‘immediately’ if the Fed goes too big with its next rate hike

After the Federal Reserve raised interest rates seven times to fight the rise of inflation last year, Siegel said that investors are betting its tactics have worked. But Siegel warns the Dow could drop 1,000 points “immediately” if the Fed goes too big with its next rate hike.

Economists and investors are optimistic, and expect the Fed to raise rates by just 25 basis points (bps) on Wednesday in the wake of the latest Federal Open Market Committee (FOMC) meeting, where officials convene eight times a year to decide interest rate policy. But Siegel warned that if chairman Jerome Powell chooses to raise interest rates by 50 basis points instead, as he did in December, it could be a disaster for investors. 

“There will be tremendous selling pressure for the risk markets, and we could easily see a 1,000-point drop in the Dow immediately,” he wrote in weekly market commentary, adding that even a 25 basis point rate hike doesn’t mean stocks are “all clear.”

Siegel said he will be carefully watching Chair Powell’s post-FOMC press conference tomorrow, where Powell has delivered hawkish remarks that sent markets lower in the past. And he added that even with a 25 basis point hike, Powell’s tone will be crucial. 

“Does Powell concede there has been much progress on the battle over inflation, or will he maintain a stubborn view that tightening must continue for much longer. The markets clearly want this to be the end, or very near the end, of the tightening cycle…but is Powell paying attention?”

Siegel has argued for months now that Fed officials are being overly aggressive in their inflation fight because they are relying on old data. In December, he said that inflation is “basically over” and Fed officials are “making a terrible mistake” by continuing to raise interest rates. 

The professor points to data that shows rent and home prices are falling, despite the supposed housing market inflation seen in the Fed’s inflation gauges. He also said on Wednesday that overall consumer demand is now “quite weak,” and economic growth is fading. 

But Siegel wasn’t all doom and gloom. He struck a more positive tone when discussing the latest earnings season this week.

“As fourth quarter earnings continue to come in, they are largely showing okay results, with a nod towards guiding lower for 2023,” he wrote. “I still hold out hope that productivity growth can rebound and support corporate profits.”

Siegel said 2023 earnings estimates from Wall Street are “conservative” and that firms will get rid of “unproductive workers” to help maintain profitability. That means, as long as the Fed doesn’t push the economy into a recession with aggressive rate hikes, stocks could rise.   

“We can have a positive backdrop for the markets,” he wrote. “But we are reliant on the Fed pivot. All eyes are on you, Powell.”

Jeffrey Roach, chief economist for LPL Financial, told Fortune that he believes the good news is that the Fed will eventually be forced to address both sides of its dual mandate—inflation and employment—by pausing rate hikes “as inflation convincingly decelerates.” 

“The Fed cannot ignore the fact that the economy is slowing and recession risks are rising,” he said.