Why stock-market investors keep falling for Fed ‘pivot’ talk — and what it will take to put in a bottom


Should you buy stocks now or wait?

The timing of the market has been a worrisome question for investors since the stock plunged 25 percent in January this year. The real answer may depend on whether the Federal Reserve follows through on plans to raise the benchmark interest rate to 4.5% or higher, as market-based indicators and the Fed’s latest forecasts expect.

Global markets are reeling from high interest rates and a 20-year high US dollar, or a domestic market downturn, or a possible emerging market crisis due to financial institution failure. to the The worst bond market turmoil in a generation.

watch out The dollar is wreaking havoc on markets: why it’s so hard to stop.

Fears that the Fed could “break” something in the global economy or financial system have prompted some to question whether the Fed can successfully beat inflation by raising interest rates at the most aggressive pace in decades.

The Fed’s efforts are already whipping markets. Almost every day.

Bill Sterling, global strategist at GW&K Investment Management, said the volatility in the market makes it difficult to know when buying opportunities will come.

Interest rates are the biggest issue for stocks.

Looking back at how the Fed has managed monetary policy compared to its own forecasts gives good reason to be skeptical about what to expect when the Fed moves to an easing policy.

It’s important to remember that stocks have often reacted positively when the Fed returns to cut interest rates. S&P 500 index since August 1984 In the 12 months following the peak in the federal funds rate range, it has risen an average of more than 17 percent (see chart). Sterling by GW&K and Fed data.

Federal Reserve, FactSt.

The chart also shows that the Nasdaq Composite and Dow Jones Industrial Average have risen sharply since the Fed raised interest rates to their highest levels in previous monetary policy tightening cycles in nearly 40 years.

The same is true for bonds, which have historically outperformed since the Fed’s interest rate hiking-cycle peak. Sterling has yielded an average return of about one-fifth in the 12 months since the Fed’s benchmark rates peaked.

Still, what separates today from the relentless inflation of the 1980s is heightened geopolitical and macroeconomic uncertainty. Tavi Costa, portfolio manager at Chriscat Capital, said the weakening US economy and fears of a crisis elsewhere in global markets are complicating the outlook for monetary policy.

But when investors look at markets and economic data, Sterling said, “backward-looking” measures such as the U.S. consumer price index and the personal consumption expenditure index are not as useful as “forward-looking” measures, such as the breakout spread on inflation-protected Treasuries. securities or derived from surveys such as University of Michigan inflation expectations.

“The market is caught between these forward-looking and encouraging signs that inflation may come as seen next year. [Treasury inflation-protected securities] It yields,” Sterling said.

Stocks started a two-day rally last week and fourth quarter after major indexes ended September 30 at 2020 lows. Gains faded later in the week as federal officials and economic data dampened investors’ expectations around the easing Fed. The “pivot” program has moved away from the brutal interest rate hike. Stocks ended the week higher, but the Dow Jones Industrial Average DJIA, -2.11% From its Sept. 30 low, the S&P 500 rose just 2%. SPX, -2.80% Reduce the weekly increase to 1.5% and the Nasdaq Composite COMP, -3.80% It increased only 0.7%.

Read: Diminished hope for a Fed stimulus is turning into a sense of dread in financial markets.

Minneapolis Federation President Neil Kashkari And Governor of the Federation Christopher Waller They were the latest hawkish comments by top Federal Reserve officials, saying policymakers have no intention of abandoning their interest rate hike plan.

However, some on Wall Street are paying less attention to what top Fed officials are saying and paying more attention to market-based indicators, including Treasury yields, relative movements in sovereign bond yields and credit-default spreads, according to Credit Suisse Inc. CS, +13.05%.

Costa at Crescat Capital said he sees a growing “disconnect” between market conditions and the Fed’s hawkish rhetoric, with the risk of a crash increasing by the day.

Because of this, he is waiting for “the other shoe to drop,” which could be an important change for the markets.

The Bank of England’s explosion last month, when it decided to inject billions of dollars of liquidity into the gilts market, is expected to eventually force the Fed and other global central banks to end their policy-tightening agenda. It is preparing to raise interest rates to fight inflation.

watch out: A Bank of England official said $1 trillion of pension fund investments could have been lost without intervention.

But before that happens, in the spring of 2020, expect the Fed to be as chaotic as it was in fixed income trading when it was forced to intervene to prevent a bond market crash at the start of the coronavirus pandemic.

“Look at the difference between Treasury yields compared to junk bond yields. We haven’t seen that spike yet, driven by default risk, which is a sign of a completely dysfunctional market,” Costa said.

watch out: Disturbances in financial markets have fueled debate about whether the next crisis is inevitable.

A quick look in the rearview mirror shows that the Fed’s interest rate hike plan is hardly what the central bank hoped for. Let’s take last year as an example.

The average forecast for the Fed-funds rate in September 2021 was just 30 basis points higher than a year ago, according to the Fed’s Forecast Survey. In the end, those predictions were off by three full percentage points.

“When trying to predict the direction of federal policy next year, don’t take the Federal Reserve at its word,” Sterling said.

Waiting for next week

Looking ahead to next week, investors will get some more insight into the state of the US economy and, indeed, the Fed’s thinking.

US inflation data will be front and center, with September’s consumer price index due Thursday. On Friday, investors will get data from the University of Michigan’s survey of consumer sentiment and inflation expectations.

Krishna Guha and Peter Williams, US economists at Evercore ISI, said the inflation data will be closely watched, especially as investors grapple with signs that the US labor market may be starting to weaken.

On Friday showed the September jobs report The US economy gained 263,000 jobs Last month, the unemployment rate fell to 3.55 to 3.7%, but job growth decreased from 537,000 in July, and 315,000 in August.

But is inflation peaking or showing signs of slowing? Many are afraid Crude oil production-quota reduction imposed by OPEC+ At the beginning of this week, prices may increase during the year.

Meanwhile, the Fed funds futures market, which allows investors to place bets on the pace of Fed rate hikes, expects another 75 basis point rate hike on November 3.

Beyond that, traders expect a 4.75% higher rate in February or March. The FedWatch tool.

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