Investors will watch for a new measure of inflation in the United States next week after the stock market was shaken by the Federal Reserve, which strengthened its hawkish tone and suggested that large interest rate increases are coming to control the overheating economy.
“We’re probably seeing a peak of the hawk right now,” said James Soloway, chief market strategist and senior portfolio manager at SEI Investments Co., in a telephone interview. “It’s no secret that the Fed is far behind the curve here, with such high inflation and so far only an increase of 25 basis points.
Fed Chairman Jerome Powell said on April 21 during a panel discussion hosted by the International Monetary Fund in Washington that the central bank did not “rely” on inflation, which peaked in March. “I think it’s appropriate to move a little faster,” Powell said, putting the interest rate increase on the table by 50 basis points for the Fed’s meeting early next month and leaving the door open for bigger moves in the coming months. .
US stocks closed sharply after his remarks and all three major benchmarks extended losses on Friday, with the Dow Jones Industrial Average marking its biggest daily decline since late October 2020. Investors are struggling with “very strong forces” in the market, according to Stephen Violin, portfolio manager at FLPutnam Investment Management Co.
“The huge economic impetus of the pandemic recovery has been met with a very rapid change in monetary policy,” Violin said by telephone. “Markets are struggling, like all of us, to understand how this will develop. I’m not sure anyone really knows the answer. “
The central bank wants to create a soft landing for the US economy by seeking to tighten monetary policy to fight the hottest inflation in about four decades without causing a recession.
The Fed is “partly to blame for the current situation, as its extremely flexible monetary policy over the past year has left it in this very weak position,” Osterweis Capital Management portfolio managers Eddie Wataru, John Sheehan and Daniel O wrote in a report on their prospects for the second quarter for the company’s total return fund.
Osterweis ‘portfolio managers said the Fed could raise the federal funds’ interest rate target to cool the economy while shrinking its balance sheet to raise longer maturities and curb inflation, but “unfortunately, the implementation of a bilateral plan “Quantitative tightening requires a level of finesse that the Fed is not known for,” they wrote.
They also expressed concern about the short, recent inversion of the government budget yield curve, in which shorter-term yields rose above long-term ones, calling it “a rarity at this stage of the tightening cycle”. This reflects a “political mistake”, in their view, which they describe as “leaving interest rates too low for too long and then a potential increase too late and probably too much”.
The Fed last month raised its key interest rate for the first time since 2018, raising it by 25 basis points from near zero. The central bank now appears to be in a position to pre-charge interest rate hikes with potentially larger increases.
“There’s something about the idea of front-end charging,” Powell said during a panel discussion on April 21. James Bullard, president of the Federal Reserve Bank of St. Louis, said on April 18 that he would not rule out a large increase of 75 basis points, although this is not his main case, according to The Wall Street Journal.
Read: Fed futures traders see 94% chance of Fed increase of 75 basis points in June, CME data show
“It is very likely that the Fed will move by 50 basis points in May,” but the stock market has a “slightly harder to absorb” idea that a half-point increase could also come in June and July, said Anthony Saglimbene, global market strategist at Ameriprise Financial, in a telephone interview.
Dow DJIA, -2.82% and S&P 500 SPX, -2.77% each fell nearly 3.0% on Friday, while Nasdaq Composite COMP, -2.55% fell 2.5%, according to Dow Jones Market Data. All three major benchmarks ended the week with losses. The Dow fell for the fourth week in a row, while the S&P 500 and Nasdaq fell for the third week in a row.
The market “returns to the idea that we will move to a more normal interest rate on funded funds much faster than we probably did,” we thought a month ago, according to Saglimbene.
“If it’s a hawk peak and they’re pushing very hard offset,” Violin said, “they may be buying more flexibility later in the year as they begin to see the impact of a very rapid return to neutral.”
A faster rate of interest rate hikes by the Fed could bring federal fund interest rates to a “neutral” target of around 2.25% to 2.5% before the end of 2022, potentially earlier than investors predicted, according to Saglimbene. The rate, which now ranges from 0.25% to 0.5%, is considered “neutral” when it neither stimulates nor restricts economic activity, he said.
Investors, meanwhile, are worried that the Fed will shrink its balance of approximately $ 9 trillion as part of its quantitative tightening program, according to Violin. The central bank is aiming for a faster rate of decline than its last quantitative tightening effort, which rocked markets in 2018. The stock market collapsed around Christmas that year.
“The current concern is that we are heading for the same point,” Violin said. When it comes to reducing the balance, “how much is too much?”
Saglimbene said he expects investors to largely “review” the quantitative tightening until the Fed’s monetary policy becomes restrictive and economic growth slows “significantly”.
The last time the Fed tried to develop its balance sheet, inflation was not a problem, said SEI’s Soloway. Now they are “watching” high inflation and “they know they need to tighten things up.”
Read: US inflation jumps to 8.5%, CPI shows, as higher gas prices hit consumers
At this point, a more hawk Fed is “deserved and needed” to combat the surge in living costs in the United States, said Luke Tilly, chief economist at the Wilmington Trust, in a telephone interview. But Tilly said he expects inflation to fall in the second half of the year and the Fed will have to slow the pace of rising interest rates “after making this pre-load.”
The market may have been “ahead of the Fed’s expectations of tightening this year,” according to Lauren Goodwin, an economist and portfolio strategist at New York Life Investments. The combination of the Fed’s boost and quantitative tightening program “could tighten financial market conditions” before the central bank can raise interest rates by as much as the market expects in 2022, she said by telephone.
Investors next week will closely monitor inflation data in March, measured by the personal consumer price index. Soloway expects PCE inflation data, due to be released by the US government on April 29, to show a rise in the cost of living, in part because “energy and food prices are rising sharply.”
Next week’s economic calendar also includes data on US house prices, new home sales, consumer sentiment and consumer spending.
Ameriprise’s Saglimbene said it would monitor next week’s quarterly corporate earnings reports from “consumer-oriented” and megacap technology companies. “They will be extremely important,” he said, citing Apple Inc. AAPL, -2.78%, Meta Platforms Inc. FB, -2.11%, PepsiCo Inc. PEP, -1.54%, Coca-Cola Co. KO, -1.45%, Microsoft Corp. MSFT, -2.41%, General Motors Co. GM, -2.14% and Google parent Alphabet Inc. GOOGL, -4.15% as examples.
Read: Investors have just withdrawn a whopping $ 17.5 billion from global equities. They are just beginning, says Bank of America.
The FLPutnam violin, meanwhile, said it was “quite comfortable to remain fully invested in the stock markets”. He cited the low risk of recession, but said he preferred here and now cash flow companies to more growth-oriented businesses with expected profits in the distant future. Violin also said he likes companies that are willing to take advantage of higher raw material prices.
“We are entering a more volatile time,” warned Soloway of the SEI. “We really need to be a little more careful about how much risk we have to take.
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