Updated January 24, 2022 at 5:01 PM ET
It was a remarkable day for stocks.
The Dow Jones Industrial Average slumped by more than 1,000 points on Monday, before staging a remarkable recovery that saw the key index end the session with a nearly 100 point gain.
It was the same story for the S&P 500 and cryptocurrencies such as Bitcoin, which also slumped earlier in the day only to come roaring back and end the day with gains.
The Nasdaq, which has been hit hard in recent days, rose 0.6% after dropping nearly 5%.
The incredibly frenzied day showcases a market that's being gripped by fears about inflation, which has surged to 40-year highs. Yet there's little certainty about what comes next.
Minutes from the Fed's latest meeting out earlier this month shocked markets by showing that policy makers are becoming much more concerned about tamping down inflation.
It's now becoming clear to investors that the central bank is moving much more aggressively to cool down prices than markets had anticipated.
How the Fed goes about doing that is tricky, however.
Higher interest rates will push up borrowing costs for consumers and corporations, and investors are trying to figure out how hard that will hit companies.
Raising rates too much could slow down the economy excessively. Yet raising them too little raises the opposite concern, that they will fail to make too much of a dent on inflation.
At the moment, Wall Street is expecting the Fed to raise interest rates four times this year, potentially starting as early as March. At some point, the Fed is also expected to begin selling assets — including bonds and securities tied to mortgages — it bought during the pandemic to prop up markets and the economy.
In a new research note, economists at Goldman Sachs said they expected the Fed to raise interest rates four times. But they added a note of caution that the Fed could raise interest rates more aggressively if inflation stays high, a process known in markets as policy tightening.
"We see a risk that the FOMC will want to take some tightening action at every meeting until that picture changes," Goldman said in a note, referring to the Federal Open Market Committee (FOMC), the group that takes interest rate decisions at the Fed.
Tech companies are routed
The uncertainty behind interest rates has hit technology companies especially hard, including Meta, Facebook's parent company, and Alphabet, which owns Google, both of which also recovered sharply toward the end of the day.
Yet deep uncertainties remain about the sector. Shares of technology companies tend to do best in high-growth economies and less so when rates start to climb.
Inflation also eats into future profits, and investors are recalibrating their expectations after technology share prices surged over the past few years.
Of course, it's hard to predict the trajectory of inflation, meaning the uncertainty in stock markets could continue for a while.
Most analysts still expect stock markets to gain this year after rising in each of the previous three.
But gains may not be quite as strong as in recent years and just like on Monday, things will likely stay very volatile. Stocks actually surged during the pandemic as consumers went on a shopping spree, while millions of amateur investors joined markets for the first time.
A lot of what happens will hinge on the progress of inflation, the economy and corporate profits.
The Fed meets on Tuesday and Wednesday, and Fed policymakers are expected to share new details about their plans to raise interest rates, although no meaningful action is expected.
On Friday, the Commerce Department is set to report several economic indicators including consumer spending as well as on inflation.
Meanwhile, a slew of companies including Microsoft and Apple are set to report earnings this week for the last three months of 2021, and investors will be keen to see how corporate profits held up during a period marked by high inflation, supply chain woes and staffing shortages.
Michael Wilson, the chief U.S. equity strategist and chief investment officer at Morgan Stanley, says he is going to pay close attention to how each company has been performing and how executives are handling higher costs.
Like tech companies, stocks that have been driven high by speculation may continue to fall, he said.
"The froth is coming out of an equity market that simply got too extended on valuation," Wilson wrote in a note to clients.
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