NEW YORK - Making money was easy for investors when they could still plausibly believe that the United States Federal Reserve might back down on its aggressive campaign to subdue inflation at any cost.

But harsh words from Fed chair Jerome Powell, backed by a string of large interest rate increases, finally convinced markets that the central bank meant business, sending stock and bond prices tumbling.

A nervous confidence returned as October began, with stocks experiencing a big two-day rally, but then prices sank anew.

Investors, at first, seemed more confident that the Fed would reverse course, but anxiety returned as they worried about how much damage would be inflicted before that happened.

Where the markets go from here, and how to position an investment portfolio, depend on whether and how deftly the Fed changes its strategy.

"A crescendo of factors is coming together that makes me think we're going to have another few weeks of pain before the Fed capitulates," said Mr Marko Papic, chief strategist at the Clocktower Group.

Mr Papic thinks a dovish turn may come soon, as the Fed signals that it would settle for inflation 2 or 3 percentage points above its 2 per cent target.

Others think more pain lies ahead, maybe a lot more.

A prerequisite for a pivot might be a "credit event", said Dr Komal Sri-Kumar, president of Sri-Kumar Global Strategies, meaning a default by a large investment firm or corporate or government borrower, often with severe consequences.

The Fed's plan is to slow inflation by slowing economic growth, and part of its plan is working.

The Conference Board reported in September that its index of 10 forward-looking indicators fell for the sixth consecutive month. The purchasing managers' index, a gauge of manufacturing, has risen in only two of the last 10 months.

But inflation remains stubbornly high, with consumer prices rising 8.2 per cent in the year through September, almost ensuring that the Fed will continue raising rates.

A growing recognition that the Fed is likely to remain hawkish has sent the S&P 500 plummeting. It lost 5.3 per cent in the third quarter, after it was up nearly 14 per cent midway through the period.

The downturn began to accelerate in late August, when Mr Powell delivered a speech at the annual economic conclave in Jackson Hole, Wyoming.

He mentioned inflation 45 times, and of the Fed's programme to bring it back to 2 per cent. He said: "We will keep at it until we are confident the job is done."

His blunt language also helped sink bond prices, which are inversely related to bond yields.

The yield on 10-year Treasury instruments rose to 4 per cent in late September from 2.6 per cent in early August, lending credibility to forecasts that the Fed would keep tightening until its benchmark interest rate hits 5 per cent.

High interest rates are not the only source of concern in the markets.

The dollar recently hit 20-year highs against other major currencies. Though a strong dollar mitigates inflation on imported goods in the US, it makes American goods and services more expensive in world markets, which worsens inflation abroad and hurts many American businesses, increasing the probability of a recession in the US.

Then there is Russia's war in Ukraine, which raises doubts that Western Europe will meet its energy needs this winter. Threats by Russia's leaders to use nuclear weapons could hit stocks hard.

If the Fed relaxes its posture, the markets might rally. But Dr Mohamed A. El-Erian, chief economic adviser at Allianz, warned that could do more harm than good.

"Now that the Fed finds itself in such an uncomfortable situation - one mostly of its own making - it may be inclined to eschew further rate hikes," he wrote in a commentary for Project Syndicate. "Yet, such a course of action would risk repeating the monetary-policy mistake of the 1970s, saddling America and the world with an even longer period of stagflationary trends."

(Stagflation - high and persistent inflation combined with tepid growth - is the worst of both worlds, economically.)

The Fed may be damned if it pivots and damned if it does not.

In a recent CNBC interview, Dr Jeremy Siegel, professor emeritus of finance at the University of Pennsylvania, accused the central bank of ignoring troublesome signs for the economy, including soft housing indicators and a collapse in growth of the money supply.

During and long after the global financial crisis of 2008, the Fed held interest rates down and bought billions of dollars worth of securities - measures that increased asset prices and supported the economy. Now, by raising rates and reducing its holdings, the Fed has depressed the value of stocks and bonds.

"Asset prices have become a lever that the Fed is using to reduce the price pressures," Mr Michael Farr, chief executive of financial advisory firm Farr, Miller & Washington, wrote in a note to investors.

"The strategy, which seems fraught with peril, is designed to trigger a reverse wealth effect, tamping down asset prices so that people feel less wealthy and therefore spend less. Lower spending means less demand, which means lower inflation. At least that's the hope."

It is a hope Mr Farr is clinging to. He noted that inflation expectation indicators show that investors "continue to believe that the Fed will be successful in bringing down inflation over the intermediate term". If it is, that would help markets recover, even in the absence of a dovish pivot.

Mr Tony DeSpirito, chief investment officer of US Fundamental Equities at BlackRock, is also optimistic.

"In the near term, I can see inflation rolling over," he said. "A number of companies are reporting excess inventories, home price growth has turned a little negative. The real question is how fast it comes down, and to what level."

He expects the consumer price index to settle around 3 per cent to 4 per cent. But inflation is likely to remain a chronic problem, in his view, as certain trends that kept it in check for decades, notably trade liberalisation, subside and the emphasis shifts from efficiency in supply chains to resiliency.

"The long-term disinflationary impulse has ended," Mr DeSpirito added.

As for short-term inflation, if the Fed is trying to curb it by actively targeting asset prices, at least it has accomplished the targeting part. The average domestic stock fund fell 4.2 per cent in the third quarter, according to Morningstar, with technology, communications and real estate portfolios underperforming.

The average international stock fund lost 9.5 per cent, with Europe and China funds faring especially poorly.

Bond funds provided no refuge, with the average portfolio down 2.7 per cent.

Given the uncertainty of the Fed's next moves, how to position an investment portfolio is especially tricky these days.

Dr Sri-Kumar advises caution towards stocks and risky corporate bonds and recommends Treasury and other high-quality bonds. The 10-year yield will not go higher than 4 per cent, he predicted.

"Remain underweight in equities, and start getting your toes wet in long-dated, highly rated debt securities," he said.

With so many uncertainties, Mr DeSpirito favours a barbell approach to stocks.

Own some in industries that do well when economic growth picks up, such as energy and financial services, and others in industries that hold up in a recession, especially health care, he said.

Anticipating a swift pivot, Mr Papic of the Clocktower Group prefers energy and industrial metal commodities.

He advises buying bonds "if you're in the camp that believes the Fed is going to break something". He does not think that the Fed will break anything, but that it might come close.

"The next couple of months are really scary," Mr Papic said, "but the Fed in November will look at a slew of factors - CPI coming down, US geopolitical allies hurting, the US economy negatively impacted - that will combine to tell them the current pace of hawkishness is not necessary". NYTIMES