We were waist deep in the Big Muddy, and the big fool said keep going.
Pete Seeger’s words describing stubborn and misguided leadership amid clearly deteriorating conditions returned last week with news that US inflation hit another four-decade high – 7.5% annualized – in January , creating the most austere consumer sentiment since 2011, during the soft recovery from the recession spurred by the 2008-09 financial crisis.
At the same time, despite growing expectations of the Federal Reserve acting to curb inflation, the central bank is maintaining its crisis stance of near-zero interest rates for now. And he is easing — not tightening — monetary policy through continued large-scale purchases of Treasury and agency mortgage-backed securities.
The anticipation that the Fed will move away from extreme accommodation continues to have repercussions on the bond markets and, by extension, on the stock markets. As the 2% overshoot of the benchmark 10-year Treasury yield for the first time since mid-2019 grabbed headlines, market pros focused on the larger rise in the two-note yield. year.
This maturity, the most sensitive to the Fed’s political expectations, reached 1.56% on Thursday, the highest since January 2020, just before the effects of the pandemic began to be felt. The more pronounced rise (37 basis points compared to the previous Friday) on the short end of the market flattened the slope of the yield curve, with the spread between two- and ten-year bonds at 44 basis points, the narrowest since August 2020, when long-term yields hit all-time lows. A flatter slope historically indicates Fed rate hikes that generally slow the economy. (A basis point is 1/100th of a percentage point.)
The moves came amid heightened rhetoric — but no action — from Fed officials over expected rate hikes at the March 15-16 Federal Open Market Committee meeting. The odds in the fed funds futures market tipped slightly to a 50 basis point upside and then, according to CME FedWatchrather than one of the 25 basis point moves that have been the rule for more than two decades, as our colleague Lisa Beilfuss notes.
Market sentiment for more aggressive hikes surged after St. Louis Fed President James Bullard told Bloomberg that he is in favor of raising the key rate to 1% by July 1, from the current target range of 0% to 0.25%.
Bullard’s comments have Wall Street banks accelerating their expected timing of Fed moves, with
Bank of America
and others calling for 25 basis point hikes at each of the remaining FOMC meetings this year, to 1.75% to 2% by December. Goldman economists still expect the funds rate to peak between 2.5% and 2.75% in 2023, albeit a little earlier than before. This would most likely leave the cost of money negative in real terms, i.e. below the rate of inflation, still “easy”, however defined.
Market expectations shifted somewhat on Friday afternoon as stock prices and bond yields fell in response to heightened tensions over a possible Russian invasion of Ukraine. National Security Adviser Jake Sullivan has urged American citizens to leave Ukraine, given the possibility that Russian President Vladimir Putin could order an attack, despite speculation he could expect during the Winter Olympics in Beijing in deference to Chinese President Xi Jinping.
The stock market hasn’t had to deal with interest rate volatility like the current surge since 1994, says Julian Emanuel, senior managing director leading the equity, derivatives and quantitative strategy team at Evercore ISI . Twenty-eight years ago this month, the Fed shocked investors with its first unexpected interest rate hike. This was followed by a series of rapid rises that further rattled fixed income and derivatives markets, but helped ease inflationary pressures without tipping the economy into a recession.
“It’s one of the things that market professionals will have to get used to,” says Emanuel. “At the margin, this will mean [price/earnings] multiple compression”, although this earnings season was favorable, but with fewer positive surprises than the previous ones.
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Investors continue to cling to the past 40 years’ experience of low inflation and falling bond yields, adds Jonathan Golub, chief U.S. equity strategist and head of quantitative research at
Just as they were slow to acknowledge the disinflation that began in the early 1980s under then-Fed Chairman Paul Volcker and continued through 2020, they remain overly optimistic about the strong lower inflation now. In particular, consensus forecasts call for annual consumer price index inflation to decline to 2.9% by the end of the year, from 7.5% recently, he wrote in a client note. .
With stocks down sharply ahead of the weekend on Russian-Ukrainian tensions, interest rate concerns seem benign compared to the possibility of war. Even before this risk appeared, Emanuel was looking for a retest of the index lows hit in late January. Beyond that, however, his advice to clients is to eat well, exercise and get enough sleep to weather the turbulence ahead.
Write to Randall W. Forsyth at [email protected]