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Stock rally fanned by hopes of Fed 'past peak hawkishness'

Published 05/27/2022, 02:45 PM
Updated 05/29/2022, 09:07 AM
© Reuters. FILE PHOTO: A Wall Street sign outside the New York Stock Exchange in New York City, New York, U.S., October 2, 2020. REUTERS/Carlo Allegri

By David Randall

NEW YORK (Reuters) -Bad news may once again be good news on Wall Street, as signs of slowing U.S. growth fan hopes that the Federal Reserve may not need to tighten policy as much as previously expected.

Home sales have fallen for a third straight month, while big misses from retail giants such as Target Corp (NYSE:TGT) and Walmart (NYSE:WMT) Inc shook their share prices last week. The Atlanta Fed's GDPNow estimate of real GDP growth for the second quarter fell to 1.8% on May 25, from 2.4% the previous week.

Softer economic growth raises risks of weaker corporate profits, in theory paving the way for softer share prices. Several Wall Street banks have in recent weeks warned that the chances of a U.S. recession are rising, along with an increased likelihood of the low-growth, high-inflation environment known as stagflation.

In the near-term, however, some investors believe a nascent slowdown could bolster the case for the Fed to pull back on an aggressive monetary policy tilt that has unnerved investors and helped drive the S&P 500 index to the cusp of the 20% decline that many call a bear market..

The index rose 6.6% this week, snapping a seven-week losing streak, though it is down around 13% for the year to date. Net weekly inflows to U.S. stocks stood at their highest level in 10 weeks, data from BofA Global Research showed Thursday.

"It's very clear that everyone at the Fed is on board for 50 basis-point (interest rate hikes) for the next two hiking meetings. But after that, it's unclear what they do, and if there is a sharp slowdown in growth, they may be able to wait a little bit," said Anwiti Bahuguna, senior portfolio manager and head of multi-asset strategy at Columbia Threadneedle Investments, who recently raised her allocation to equities.

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Concerns over the impact of higher rates at a time when inflation may have peaked will likely mean the central bank will pause its tightening in September, leaving its benchmark overnight interest rate in a range of 1.75% to 2% if financial conditions worsen, BofA strategists said in a note.

Expectations of Fed hawkishness have eased, with investors now pricing in a 35% probability that the Fed funds rate will be between 2.25% and 2.50% after its September meeting, down from a 50% probability a week ago, according to CME.

The Fed has already raised rates by 75 basis points this year. Minutes from the central bank’s latest meeting showed officials grappling with how best to navigate the economy toward lower inflation without causing a recession or pushing the unemployment rate substantially higher.

Signs that growth may be slowing have helped bolster Treasury prices, suggesting investors are increasingly looking to bonds for safety rather than as assets that could be at risk during times of high inflation, said Anders Persson, chief investment officer of global fixed income at Nuveen.

Yields of benchmark 10-year Treasuries, which move inversely to prices, hit a six-week low of 2.706% on Thursday, after soaring to as high as 3.14% this month.

"The market is pricing in a slowdown," but not a recession, Persson said, making riskier parts of the fixed-income market, such as high yield bonds, more attractive.

U.S. data on Friday also showed price increases may be slowing. The personal consumption expenditures (PCE) price index rose 0.2%, the smallest gain since November 2020, after shooting up 0.9% in March.

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A potentially less hawkish Fed is not necessarily a green light for equity buyers over the long term. With inflation at its highest in decades, concerns have grown over impending stagflation, a phenomenon that weighed heavily on all asset classes during the supply shocks of the 1970s.

Among those sounding the warning are hedge fund manager Bill Ackman, a member of the Fed’s investor advisory committee on financial markets, who on Twitter (NYSE:TWTR) this week urged the central bank to quell inflation by raising rates more aggressively.

Meanwhile, Citi's global asset allocation team this week cut its U.S. equity allocation to "neutral," saying, "While a U.S. recession is not the base case for Citi economics, uncertainty is very high."

Some investors, however, believe a turning point may be near.

Esty Dwek, chief investment officer at FlowBank, is betting the central bank will begin to see signs that inflation and growth are slowing by August, when policymakers hold their annual meeting in Jackson Hole, Wyoming.

"The Fed is past peak hawkishness," she said.

Latest comments

Look at historical figures of Core PCE year over year chart vs the stock market back 50 years. When Core PCE starts going up, stocks start going down. When Core PCE peaks and starts going down, stocks bottom and starts going up. It's no coincidence. Also, inflation started in May, 2021. As time progresses, the denominator (last year) goes up, reducing the Core PCE year over year calculation. Further more, China is reopening, reducing supply chain issues. Russia is ready to lift Ukraine food blockade in return for sanctions relief. YouTube videos of ordinary people shows very few people at the malls and food prices up 100% or more. Companies go bankrupt in that type of scenarios. Market will bounce much higher, at minimum. If inflation drops to 2-3% by middle next year, very possible these are the lows.
YouTube videos of Moscow, Russia, that is. Look for yourselves.
The Fed has raised interest rates by a grand total of 0.75%, has not yet even started QT, and the market is already calling for a pause? Are you kidding me? How fragile is our economy? Apparently, very fragile.
the commodity super cycle had begun which was the result of poor policy choices. this will keep upward pressure on inflation especially with oil @ $110 a barrel. also, the fed will begin QT in June which will definitely increase volatility. margins will continue to weaken, consumer demand will decline, and more emerging markets will default. get ready for the next leg down once q2 earnings season kicks off
Oil all time high on futures / food prices set to explode. The Fed is bought and paid for but they have no way out and no bailouts for Banks this time when it implodes in six months. Banks are resisting cash withdrawals already. Everyone know how this ends. No bailouts this time.
unless there are a chain of defaults that csuse banks to realize significant losses than what you speak of is unlikely.
News is starting to leak out of China of banks beginning to freeze accounts and deny withdrawal requests, indicating that those banks are no longer solvent. Apparently that started back in April with some local banks. It will probably spread to larger banks.
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