‘Peak hawkishness’? Investors look forward to the next inflation gauge after stocks rattled by the Fed, suggesting interest rates were on the horizon

Investors will look to see another gauge of US inflation this week, after the stock market was rocked by the Federal Reserve stepping up its aggressive tone, suggesting major rate hikes are imminent to contain an overheated economy.

“We’re probably seeing a spike in hawkishness right now,” James Solloway, chief market strategist and senior portfolio manager at SEI Investments Co., said in a phone interview. “It’s no secret that the Fed is lagging far behind, with inflation so high and only one gain of 25 basis points in its pocket so far.”

Fed Chair Jerome Powell said on April 21 during a panel discussion hosted by the International Monetary Fund in Washington that the central bank is not “counting” inflation to peak in March. “I think it’s appropriate to act a little faster,” Powell said, “putting a 50 basis point rate hike on the table” ahead of the Fed’s meeting early next month.

US stocks closed sharply lower after his comments and all three major benchmarks extended losses Friday, with the Dow Jones Industrial Average posting its largest daily percentage drop since late October 2020. Investors are grappling with “very strong forces” in the market, Steven said. Violin, a portfolio manager at FLPutnam Investment Management Co.

“The tremendous economic momentum from the recovery from the pandemic is being met with a very rapid shift in monetary policy,” Violin said by telephone. “Markets, like all of us, are struggling to understand how that’s going to play out. I’m not sure if anyone really knows the answer.”

The central bank wants to bring about a soft landing for the US economy, with the aim of tightening monetary policy to combat the highest inflation in about four decades without triggering a recession.

The Fed “is partly responsible for the current situation, as its extremely accommodative monetary policy over the past year has put it in this very weak position,” portfolio managers Eddy Vataru, John Sheehan and Daniel Oh of Osterweis Capital Management wrote in a report. their second-quarter outlook for the company’s total return fund.

Osterweis portfolio managers said the Fed could raise its target Fed Funds rate to cool the economy while shrinking its balance sheet to offset longer maturities and contain inflation, but “unfortunately, implementing a two-pronged quantitative tightening plan a level of finesse. which the Fed is not known for,” they wrote.

They were also concerned about the recent inversion of the Treasury yield curve, where shorter rates rose above long-term rates, calling it “a rarity at this stage of a tightening cycle.” That, they say, reflects “a policy flaw,” which they described as “leaving rates too low for too long, then possibly too late, and probably walking too much.”

The Fed raised its benchmark rate last month for the first time since 2018, raising it 25 basis points from near zero. The central bank now appears to be positioning itself to bring forward its rate hikes with potentially larger hikes.

“There’s something about the idea of ​​front-end loading,” Powell noted during the panel discussion on April 21. James Bullard, president of the Federal Reserve Bank of St. Louis, said on April 18 he wouldn’t rule out a big 75 basis point hike, although that’s not his base case, The Wall Street Journal reported.

Read: Fed fund futures traders see a 94% probability of a 75 basis point Fed hike in June, CME data shows

“It’s very likely that the Fed will move 50 basis points in May,” but the stock market is having “a little harder time” digesting the idea that there could be half-point gains in June and July as well, Anthony said. Saglimbene, global market strategist at Ameriprise Financial, in a telephone interview.

The Dow DJIA,
-2.82%
and S&P 500 SPX,
-2.77%
each fell nearly 3.0% on Friday, as the 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 each fell for the third week in a row.

The market is “resetting to the idea that we are moving to a more normal fed funds rate much faster than we probably thought” a month ago, according to Saglimbene.

“If this is the highest hawkish and they’re pushing really hard at the offset,” Violin said, “maybe they buy themselves more flexibility later in the year as they start to see the impact of going back to neutral very quickly.”

A faster pace of Fed rate hikes could push Federal Funds interest rates to a “neutral” target of about 2.25% to 2.5% by the end of 2022, possibly earlier than investors had estimated, Saglimbene said. The rate, now in the 0.25% to 0.5% range, is considered “neutral” if it does not stimulate or curtail economic activity, he said.

Meanwhile, investors are concerned that the Fed is shrinking its balance sheet of about $9 trillion as part of its quantitative tightening program, Violin said. The central bank is aiming for a faster rate of reduction compared to its latest attempt at quantitative tightening, which shook markets in 2018. The stock market crashed around Christmas that year.

“The current fear is that we are headed for that same point,” Violin said. When it comes to reducing the balance, “how much is too much?”

Saglimbene said he expects investors to largely “look beyond” quantitative tightening until the Fed’s monetary policy becomes restrictive and economic growth slows “more materially”.

The last time the Fed tried to reduce its balance sheet, inflation wasn’t an issue, SEI’s Solloway said. Now they are “staring at” high inflation and “knowing they need to tighten things up.”

Read: US inflation rises to 8.5%, CPI shows as higher gas prices hit consumers

At this stage, a more aggressive Fed is “deserved and necessary” to stem the rise in the cost of living in the US, Luke Tilley, chief economist at Wilmington Trust, said in a telephone interview. But Tilley said he expects inflation to ease in the second half of the year, and the Fed will have to slow the pace of its rate hikes “after they do that frontloading.”

According to Lauren Goodwin, economist and portfolio strategist at New York Life Investments, the market may have “got ahead of expectations for Fed tightening this year.” The combination of the Fed’s ascending and quantitative tightening program “could cause financial market conditions to tighten” before the central bank is able to raise interest rates by as much as the market expects in 2022, she said by phone.

Investors will pay close attention to March inflation data next week, as measured by the consumer spending price index. Solloway expects PCE inflation data, scheduled 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 soaring.”

Next week’s economic calendar also includes data on US home prices, new home sales, consumer confidence and consumer spending.

Ameriprise’s Saglimbene said he will be watching quarterly corporate earnings reports from “consumer-oriented” and mega-cap tech companies next week. “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’s parent company, Alphabet Inc. GOOGL,
-4.15%
as examples.

Read: Investors just took out a whopping $17.5 billion from global equities. They’re just getting started, says Bank of America.

Meanwhile, FLPutnam’s Violin said he’s “pretty comfortable staying fully invested in stock markets.” He cited a low risk of a recession, but said he prefers companies with cash flows “here and now” rather than more growth-oriented companies whose profits are expected far into the future. Violin also said he likes companies poised to take advantage of higher commodity prices.

“We have entered a more volatile time,” SEI’s Solloway warned. “We really need to be a little bit more careful about how much risk we have to take.”

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