Some investors are aware that the Federal Reserve could over-tighten monetary policy in its bid to rein in inflation, as markets anticipate a reading this week from the Fed’s preferred indicator of the cost of living in the states. -United.
“Fed officials have tried to scare investors almost daily recently with speeches declaring they will continue to raise the federal funds rate,” the central bank’s benchmark interest rate, “until ‘until inflation breaks,” Yardeni Research said in a note Friday. The memo suggests they went “trick or treat” ahead of Halloween, as they have now entered their “blackout period” ending the day after their November 1-2 political meeting concluded.
“The growing fear is that something else will break along the way, like the whole US Treasuries market,” Yardeni said.
Treasury yields have soared recently as the Fed raises its benchmark interest rate, putting pressure on the stock market. Their rapid ascent came to a halt on Friday, as investors digested reports suggesting the Fed could be debating a modest slowdown in aggressive rate hikes at the end of this year.
Stocks jumped sharply on Friday as the market weighed in what was seen as a potential start to a Fed policy shift, even as the central bank appeared poised to continue a path of steep rate hikes this year to curb the surge. of inflation.
The stock market’s reaction to the Wall Street Journal’s report that the central bank appears poised to raise the federal funds rate by three-quarters of a percentage point next month – and that Fed officials may be debating whether to up half a percentage point in December – sounded overly enthusiastic to Anthony Saglimbene, chief market strategist at Ameriprise Financial.
“It’s wishful thinking” that the Fed is heading for a pause in rate hikes because it will likely leave future rate hikes “on the table,” he said in a phone interview.
“I think they painted themselves into a corner when they left interest rates at zero all last year” while buying bonds under what’s called quantitative easing, he said. Saglimbene. As long as high inflation remains sticky, the Fed will likely continue to hike rates while recognizing that those hikes operate with a lag — and could do “more damage than they want” in trying to cool the economy.
“Something in the economy can break in the process,” he said. “That’s the risk we find ourselves in.”
Higher interest rates mean it costs more for businesses and consumers to borrow, slowing economic growth amid heightened fears that the United States faces a potential recession next month. next year, according to Saglimbene. Unemployment could rise due to the Fed’s aggressive rate hikes, he said, while “dislocations in currency and bond markets” could emerge.
American investors have seen such cracks in financial markets abroad.
The Bank of England recently made a surprise intervention in the UK bond market after yields on its government debt soared and the pound tumbled amid concerns over a tax cut plan that has surfaced as Britain’s central bank tightened monetary policy to curb high inflation. Prime Minister Liz Truss resigned in the wake of the chaos, just weeks after taking the top job, saying she would leave as soon as the Conservative Party held a competition to replace her.
“The experiment is over, if you will,” JJ Kinahan, CEO of IG Group North America, the parent company of online brokerage Tastyworks, said in a phone interview. “So now we’re going to have a different leader,” he said. “Normally you wouldn’t be happy with that, but from the day she arrived her policies have been pretty badly received.”
Meanwhile, the U.S. Treasury market is “fragile” and “vulnerable to shocks,” Bank of America strategists warned in a BofA Global Research report dated Oct. 20. They expressed concern that the Treasury market “could be one shock away from how the market works.” challenges”, highlighting deteriorated liquidity in a context of weak demand and “high investor risk aversion”.
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“The fear is that a debacle like the recent one in the UK bond market could happen in the US,” Yardeni said in his note on Friday.
“While anything seems possible these days, especially the scary scenarios, we would like to emphasize that even if the Fed withdraws liquidity” by raising the federal funds rate and continuing quantitative tightening, the United States is a safe haven in these challenging times globally, the company said. In other words, the notion that “there is no other country” in which to invest other than the United States can provide liquidity to the domestic bond market, according to its rating.
“I just don’t think this economy is working” if the 10-year Treasury yield TMUBMUSD10Y,
rating is starting to approach nearly 5%, Rhys Williams, chief strategist at Spouting Rock Asset Management, said by phone.
Ten-year Treasury yields fell just over a basis point to 4.212% on Friday, after climbing Thursday to their highest rate since June 17, 2008 based on 3 p.m. the East, according to Dow Jones Market Data.
Williams said he’s worried that rising finance rates in the housing and auto markets will pinch consumers, causing sales to slow in those markets.
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“The market has more or less priced in a mild recession,” Williams said. If the Fed were to continue to tighten, “without paying any attention to what is happening in the real world” while being “maniacally focused on unemployment rates”, there would be “a very big recession”, he said. he says.
Investors anticipate that the trajectory of unusually large rate hikes from the Fed this year will eventually lead to a weaker labor market, dampening demand in the economy as part of its efforts to curb soaring inflation. But the labor market has so far remained strong, with a historically low unemployment rate of 3.5%.
George Catrambone, head of trading for the Americas at DWS Group, said in a phone interview that he was “quite worried” that the Fed might tighten monetary policy excessively or raise rates too much too quickly.
The central bank “told us it was data dependent”, he said, but expressed concern about relying on data “at least a month back”, he said. .
The unemployment rate, for example, is a lagging economic indicator. The housing component of the consumer price index, a measure of U.S. inflation, is “sticky, but also particularly lagging,” Catrambone said.
At the end of next week, investors will get a reading of the Personal Expenditure Consumption Price Index, the Fed’s preferred inflation gauge, for September. The so-called PCE data will be released before the US stock market opens on October 28.
Meanwhile, corporate earnings results, which have started to be released for the third quarter, are also “retrospective”, Catrambone said. And the US dollar, which has soared with the Fed’s rate hike, is creating “headwinds” for US companies with multinational companies.
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“Because of the lag with which the Fed operates, you won’t know until it’s too late that you’ve gone too far,” Catrambone said. “That’s what happens when you move with such speed but also such magnitude,” he said, referring to the central bank’s string of big rate hikes in 2022.
“It’s much easier to tiptoe when you raise rates 25 basis points at a time,” Catrambone said.
In the United States, the Fed is on a “tight rope” as it risks tightening monetary policy, according to IG’s Kinahan. “We haven’t seen the full effect of what the Fed has done,” he said.
While the labor market looks strong at the moment, the Fed is tightening in a slowing economy. For example, sales of existing homes have fallen as mortgage rates climb, while the Institute for Supply Management’s manufacturing survey, a barometer of US factories, fell to a 28-month low of 50.9. % in September.
In addition, problems in financial markets could emerge unexpectedly as a ripple effect from Fed monetary tightening, Spouting Rock’s Williams warned. “Any time the Fed raises rates this quickly, that’s when the water comes out and you find out who has the bathing suit” — or not, he said.
“You just don’t know who’s overleveraged,” he said, raising concerns about the potential for illiquidity explosions. “You only know when you get that margin call.”
US stocks ended sharply higher on Friday, with the S&P 500 SPX,
Dow Jones DJIA Industrial Average,
and Nasdaq Composite each posting their biggest weekly percentage gains since June, according to Dow Jones Market Data.
Still, US stocks are in a bear market.
“We have advised our advisors and clients to remain cautious for the remainder of this year, building on quality assets while remaining focused on the United States and considering defensive areas such as healthcare. that can help mitigate risk, said Ameriprise’s Saglimbene. “I think the volatility is going to be high.”