Why stock market investors fear ‘something else is going to break’ as the Fed attacks inflation

Some investors are concerned that the Federal Reserve may over-tighten monetary policy in its attempt to tame hyperinflation, as markets look forward to this coming week’s reading of the Fed’s preferred measure of the US cost of living.

Federal Reserve officials They’ve been scrambling to scare investors out almost every day with speeches announcing that they would keep raising the Federal Reserve, “the central bank’s benchmark interest rate,” until inflation breaks, Yardeni Research said in a note on Friday. Treat” before Halloween because they have now entered a “blackout period” which ends the day after their November 1-2 policy meeting concludes.

“The growing fear is that something else is going to break along the way, like the entire US Treasury market,” Yardeni said.

Treasury yields have risen recently as the Federal Reserve raised its benchmark interest rate, putting pressure on the stock market. On Friday, its rapid rise was paused, as investors digested reports that the Federal Reserve may discuss a slight slowdown in rate hikes later this year.

Stores I jumped sharply on Friday As the market weighed what was seen as a potential beginning of a shift in Fed policy, even as the central bank appeared ready to continue on the path of significant interest rate increases this year to curb spiraling inflation.

stock market reaction to The Wall Street Journal report That the central bank appears set to raise the federal funds rate by three-quarters of a percentage point next month — and that Fed officials may debate whether to raise half a percentage point in December — sounded very excited to Anthony Saglimpin, chief market strategist at Ameriprise Financial .

“It’s wishful thinking” that the Fed is heading toward a pause in raising interest rates, he said in a phone interview, as they will likely leave future rate hikes “on the table.”

“I think they got themselves into trouble when they kept rates at zero for the last year” while buying bonds under so-called quantitative easing, Saglimpin said. As long as high inflation remains constant, the Fed will likely keep raising interest rates recognizing that these hikes are delaying – and could do “more damage than they want” to try to cool the economy.

“Something in the economy could collapse in the process,” he said. “This is the danger we find ourselves in.”

“disaster”

Higher interest rates mean it is costing more to borrow for businesses and consumers, slowing economic growth amid growing concerns that the United States faces a possible recession next year, according to Saglimpin. He said the unemployment rate could rise as a result of the Fed’s hike in interest rates, while “turmoil in the currency and bond markets” could emerge.

US investors have seen such cracks in financial markets overseas.

The Bank of England recently made a surprise intervention in the British bond market after government debt yields rose and the British pound fell amid concerns about a tax cut plan that surfaced while the Bank of England was tightening monetary policy to curb high inflation. Prime Minister Liz Truss step down in the wake of chaos, Just weeks after taking the top positionShe will leave as soon as the Conservative Party holds a contest to replace her.

The trial is over, if you will,” JJ Kinahan, CEO of IG Group North America, mother of online brokerage Tastyworks, said in a phone interview. “So now we’re going to get a different leader,” he said. “Normally you wouldn’t be happy about that, but since the day she came in, her policies have been very poorly received.”

Meanwhile, the US Treasury market is “fragile” and “vulnerable to shock,” Bank of America strategists warned in an Oct. 20 BofA Global Research report. ”, referring to the deterioration of liquidity amid weak demand and the “high risk aversion of investors.”

Read: BofA says ‘fragile’ Treasury market is at risk of ‘mass-scale forced selling’ or surprise leading to collapse

“The fear is that a catastrophe like the one that occurred recently in the UK bond market could happen in the US,” Yardeni said in her Friday note.

“While anything seems possible these days, especially frightening scenarios, we would like to point out that even as the Fed pulls out liquidity” by raising the Fed funds rate and continuing with quantitative tightening, the US is a safe haven amid tough times Globally, the company said. In other words, the idea that “there is no alternative country” to invest in other than the United States, might provide liquidity to the domestic bond market, according to her observation.

Yardeni research note dated October. 21, 2022

‘I don’t think this economy is working’ if the 10-year Treasury yield is TMUBMUSD10Y,
4.228%
Reese Williams, chief strategist at Spouting Rock Asset Management, said by phone that the note is starting to approach about 5%.

Ten-year Treasury yields fell just over one basis point to 4.212% on Friday, after climbing Thursday to their highest since June 17, 2008 based on Eastern time levels at 3 p.m., according to Dow Jones Market data.

Williams said he is concerned that rising financing rates in the housing and auto markets will pinch consumers, slowing sales in those markets.

Read: Why the housing market should prepare for double-digit mortgage rates in 2023

“The market is fairly priced in a mild recession,” Williams said. He said that if the Fed continues to tighten, “without paying any attention to what’s happening in the real world” while “insanely focused on unemployment,” there would be a “very big recession.”

Investors expect that the Fed’s path of unusually high interest rates this year will eventually lead to a softer labor market, dampening demand in the economy in its efforts to curb high inflation. But the job market has so far remained strong, with historically Low unemployment rate of 3.5%.

George Catrambone, head of Americas trading at DWS Group, said in a phone interview that he was “somewhat concerned” about the potential for the Fed to over-tighten monetary policy, or raise interest rates too quickly.

He said the central bank “told us that they rely on data”, but expressed concerns about relying on data that is “going backwards for at least a month”.

The unemployment rate, for example, is a lagging economic indicator. Shelter component of Consumer Price Index“Consistent, but especially lagging,” said Catrampon, a measure of US inflation.

Next weekend, investors will get a reading from the Personal Consumption Price Index and expenditures, the Fed’s preferred inflation measure, for September. The so-called PCE data will be released before the US stock market opens on October 28.

Meanwhile, corporate earnings results, which began to be announced for the third quarter, are also “lagging,” Catrambone said. And the US dollar, which rose as the Federal Reserve raised interest rates, is so Creating a “headwind” For US companies that have multinational corporations.

Read: Stock market investors are preparing for a more active week in earnings season. Here’s how it stacks up so far.

“Because of the delays the Fed is working on, you won’t know until it is too late that you have gone too far,” Catrampon said. “This is what happens when you move at that speed but also that size,” he said, referring to the series of big central bank rate hikes in 2022.

“It’s a lot easier to tiptoe when you raise rates 25 basis points at a time,” Catrambone said.

‘tightrope’

In the US, the Federal Reserve is on a “tightrope” as it risks 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 job market is looking strong at the moment, the Fed is narrowing down the sluggish economy. for example, Existing home sales are down With mortgage rates on the rise, while the Institute for Supply Management’s manufacturing survey, a barometer of US factories, It fell to its lowest level in 28 months 50.9% in September.

Also, turmoil in financial markets could unexpectedly emerge as a ripple effect of the Fed’s monetary tightening, Spouting Rock’s Williams warned. “Anytime the Fed raises rates so quickly, it’s when the water runs out and you find out who’s wearing a bathing suit” — or not, he said.

“You just don’t know who’s overdoing it,” he said, sparking concern about the potential for explosions in liquidity. “You only know that when you receive that margin call.”

US stocks closed sharply higher on Friday, with the S&P 500 SPX,
+ 2.37%And the
Dow Jones Industrial Average DJIA,
+ 2.47%
The Nasdaq Composite both posted their biggest weekly percentage gains since June, according to market data from Dow Jones.

US stocks are still in a bear market.

“We have advised our advisors and clients to remain cautious through the rest of this year,” Ameriprise’s Saglimbin said, focusing on high-quality assets with an eye on the United States and looking at defensive areas such as healthcare that could help mitigate risks. “I think the volatility will be high.”

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