Some investors are confident the Federal Reserve could tighten monetary policy too much to stave off tepid inflation, as markets await a reading this week from the Fed’s preferred gauge of US cost of living.
“fed officials They have struggled to scare investors almost every day lately, declaring they will continue to raise the federal funds rate, the central bank’s benchmark interest rate, “until inflation breaks down,” Yardeni Research said in a note on Friday. The memo says they went “trick or treating” before Halloween as they enter a “dark period” that ends the day after their Nov. 1-2 political meeting.
“Like the entire U.S. Treasury bond market, there’s a fear that something else is going to break down down the road,” Yardeni said.
Treasury yields have risen recently as the Fed’s benchmark interest rate hikes put pressure on the stock market. Their rapid gains were halted on Friday as investors digested reports that the Fed may hold talks that could slightly slow its aggressive rate hikes later this year.
Shares It jumped sharply on Friday as the market assesses what is seen as a potential start to a change in Fed policy, even as the central bank looks poised to continue its path of big rate hikes this year to curb rising inflation.
The reaction of the stock market “The Wall Street Journal” report With the central bank poised to raise the federal funds rate by three-quarters of a percentage point next month and Fed officials likely to discuss whether to raise rates by half a percentage point in December — it seemed too bullish for chief market strategist Anthony Saglimbene. at Ameriprise Financial.
It is “fantasy thinking” that the Fed is heading for a pause in rate hikes, as they are likely to leave future rate hikes “on the table,” he said in a telephone interview.
“I think they backed themselves into a corner when they cut interest rates to zero all last year,” Saglimbene said. As long as high inflation remains sticky, the Fed will likely continue to raise rates, recognizing that those hikes are running on lag — and “could do more damage than they intended” as they try to cool the economy.
“In the process, something in the economy may be disrupted. “That’s the risk we find ourselves in.”
According to Saglimbene, higher interest rates mean more borrowing costs for companies and consumers, slowing economic growth amid growing fears that the U.S. will face a potential recession next year. According to him, as a result of the Fed’s aggressive rate hikes, unemployment may increase, and at the same time, “dislocations in currency and bond markets” may occur.
US investors have seen such financial market cracks abroad.
The Bank of England recently made a surprise intervention in the UK bond market after government debt yields rose and the British pound weakened amid concerns over a tax cut plan that comes as the Bank of England tightens monetary policy to curb high inflation. Prime Minister Liz Truss fell down in the wake of chaos, a few weeks after taking the top jobThe conservative party said that he will leave as soon as he nominates his replacement.
“The experiment is over,” JJ Kinahan, chief executive of IG Group North America, the head of online brokerage tastyworks, said in a telephone interview. “Now we will get a different leader,” he said. “Normally, you wouldn’t be happy about that, but since the day he came in, his policies have been pretty bad.”
Meanwhile, the US Treasury market is “fragile” and “susceptible to shocks,” Bank of America strategists warned in an October report from BofA Global Research. 20. They pointed to deteriorating liquidity amid weak demand and “increased investor risk aversion” and expressed concern that the Treasury market “could be one shock away from market-making challenges.”
Read: ‘Fragile’ Treasury market at risk of ‘massive forced selling’ or surprise, says BofA.
“The fear is that something like the recent crisis in the UK bond market could happen in the US,” Yardeni said in a note on Friday.
“While anything seems possible these days, especially the scary scenarios, we would like to point out that even if the Fed withdraws liquidity” by raising the Fed funds rate and continuing quantitative tightening, the US is a safe haven in tough times globally. the firm said. In other words, the concept of “no alternative country” to invest in other than the United States can provide liquidity to the domestic bond market, he noted.
10-year Treasury yield “I just don’t think this economy is working”
The note is starting to approach anywhere near 5%, Rhys Williams, chief strategist at Spouting Rock Asset Management, noted by phone.
Ten-year Treasury yields fell just over a basis point to 4,212% on Friday after hitting their highest level since June 17, 2008 on Thursday, according to Dow Jones Market Data.
Williams said he worries that rising financing rates in the housing and auto markets will squeeze consumers and slow sales in those markets.
Read: Why should the housing market adjust to double-digit mortgage rates in 2023?
“The market is more or less priced into a mild decline,” Williams said. It would be “a very big recession” if the Fed continued to tighten “while focusing maniacally on unemployment rates” “without paying attention to what’s happening in the real world.”
Investors expect the Fed’s path to unusually large rate hikes this year will eventually lead to a softer labor market and reduce demand in the economy in an effort to curb rising inflation. But the labor market has historically remained strong to date low unemployment rate of 3.5%.
George Catrambone, head of Americas trading at DWS Group, said in a telephone interview that he was “quite concerned” about the Fed potentially tightening monetary policy too much or raising rates too quickly.
The central bank “told us they were dependent on the data,” he said, but said he was concerned it was relying on data “that goes back at least a month.”
For example, the unemployment rate is a lagging economic indicator. Shelter component consumer price indexThe U.S. inflation measure is “sticky, but also notably lagging,” Catrambone said.
Later next week, investors will get a reading from the personal consumption-expenditure-price index, the Fed’s preferred inflation gauge for September. The so-called PCE data will be released before the US stock market opens in October. 28.
Meanwhile, corporate earnings results, which have begun to be reported for the third quarter, are also “backward,” Catrambone said. So is the U.S. dollar, which has appreciated as the Fed hikes interest rates creating “headwinds”. for US companies with multinational businesses.
Read: Stock market investors are gearing up for the busiest week of the earnings season. Here’s how it stacks up so far.
“Because of the slowness with which the Fed operates, you don’t know you’ve gone too far until it’s too late,” Catrambone said. “That’s what happens when you move at this speed and at this scale,” he said, referring to the central bank’s string of big rate hikes in 2022.
“It’s very easy to tiptoe when you’re raising rates 25 basis points at a time,” Catrambone said.
In the US, the Fed is “on a tightrope” as it faces the risk of tightening monetary policy, according to IG’s Kinahan. “We haven’t seen the full impact of what the Fed has done,” he said.
While the labor market looks strong right now, the Fed is tightening against a slowing economy. For example, existing home sales failed As mortgage rates rise, the Institute for Supply Management’s manufacturing survey, a barometer of American factories, It fell to a 28-month low in September it was 50.9%.
Also, problems in financial markets could unexpectedly appear as a ripple effect of the Fed’s monetary tightening, warned Spouting Rock’s Williams. “When the Fed raises interest rates this quickly, the water goes out and you find out who has the bathing suit,” he said.
“You just don’t know who’s overserved,” he said, adding to concerns about the potential for illiquidity to explode. “You only know that when you get a margin call.”
US stocks ended Friday with the S&P 500 sharply higher
Dow Jones Industrial Average
and the Nasdaq Composite had their biggest weekly percentage gain since June, according to Dow Jones Market Data.
Still, US stocks are in a bear market.
“We have advised our advisors and clients to be cautious for the rest of this year,” Ameriprise’s Saglimbene said, while focusing on the U.S. to lean on quality assets and consider defensive sectors such as health care that could help mitigate risk. “I think volatility is going to be high.”
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