What’s next for the stock market as the Fed moves toward the height of the peak of hawkishness

Federal Reserve Chairman Jerome Powell said on April 21 during a panel discussion hosted by the International Monetary Fund in Washington that the central bank is not “reliant” on inflation after it peaked in March. “It is appropriate in my opinion to have Moving a little fasterPowell said, putting a 50 basis point rate hike “on the table” for the Federal Reserve’s meeting early next month and leaving the door open for more massive moves in the coming months.

US stocks closed sharply lower after his comments and all three major indices Extended losses on Fridaywith the Dow Jones Industrial Average posting its biggest daily percentage drop since late October 2020. Investors are grappling with “very strong forces” in the market, according to Stephen Violin, portfolio manager at FLPutnam Investment Management Co.

“The massive economic momentum from the recovery from the pandemic is being matched by a very rapid shift in monetary policy,” Kaman said by phone. “Markets are struggling, as we all are, to understand how this happens. I’m not sure anyone really knows the answer.”

The central bank wants to engineer a soft landing for the US economy, with the goal of tightening monetary policy to fight the hottest inflation in nearly four decades without causing a recession.

Osterweis Capital Management’s portfolio managers, Eddie Vattaro, John Sheehan, and Danielle Oh, wrote in a report on their second quarter forecast for the company’s total return fund.

Governor Osterweis said the Fed could raise its target fed funds rate to cool the economy while shrinking its balance sheet to raise longer maturities and contain inflation, but “unfortunately, implementing a two-pronged quantitative tightening plan requires a level of precision about which the Fed is not known.”

They also raised concerns about the Treasury yield curve summary, The last coup, where short-term yields rose above long-term yields, describing it as “rare at this point in the tightening cycle”. This reflects a “policy error” in their view, which they describe as “leaving rates too low for too long, potentially rising too late, perhaps too much”.

Last month, the Federal Reserve raised its benchmark interest rate for the first time since 2018, raising it by 25 basis points from near zero. The central bank now appears to be in a position to pre-load its rate increases with the potential for larger increases.

“There is something about the idea of ​​front loading,” Powell said during a panel discussion on April 21, and James Pollard, president of the Federal Reserve Bank of St. Louis, said April 18 that he would not rule out Huge high 75 basis pointsalthough that’s not his primary case, the Wall Street Journal reported.

Read: Fed fund futures traders show a 94% chance of a Fed hike of 75 basis points in June, CME data shows

“It is very likely that the Fed will move 50 basis points in May,” Anthony said, but the stock market is having “a bit of a hard time absorbing” the idea that half point increases may also come in June and July. Saglimbene, global market strategist at Ameriprise Financial, in a phone interview.

The Dow DJIA,
-2.82%
and the S&P 500 SPX,
-2.77%
Both are down about 3.0% on Friday, while the Nasdaq Composite is down,
-2.55%
It is down 2.5%, according to market data from Dow Jones. All three major indices ended the week with losses. The Dow Jones fell for the fourth consecutive week, while the S&P 500 and Nasdaq witnessed their third consecutive week of decline.

According to Saglimbin, the market is “resetting this idea that we’re going to move to a more natural rate on the fed funds much faster than we thought” a month ago.

“If this is the height of the hawks, and they are pushing hard at first, maybe they will buy themselves more flexibility later in the year when they start to see the effect of a quick return to neutrality,” Kaman said.

An acceleration of interest rate increases by the Federal Reserve could raise the federal funds rate to a “neutral” target level of about 2.25% to 2.5% before the end of 2022, potentially closer than investors had expected, according to Saglimpin. He said the rate, now between 0.25% and 0.5%, is considered “neutral” when it is not stimulating or restricting economic activity.

Meanwhile, investors are concerned that the Fed will shrink its roughly $9 trillion balance sheet under its quantitative tightening program, according to Kaman. The central bank aims to accelerate the pace of reduction compared to its recent efforts at quantitative tightening, which Turbulent Markets in 2018. The stock market plunged About Christmas that year.

“The current concern is that we’re headed to the same point,” Kaman said. When it comes to reducing the balance sheet, “What is too much?”

Saglimpin said he expects investors will probably “look past” too much into quantitative tightening until the Fed’s monetary policy becomes tight and economic growth slows down “more materially”.

The last time the Fed tried to work out its balance sheet, SEI’s Soloway said, inflation wasn’t an issue. Now they are “staring at” high inflation and “knowing they have to tighten things up”.

Read: US inflation jumps to 8.5%, CPI shows, as rising gas prices slam consumers

At this point, “the Fed deserves the toughest and most necessary” to combat the sudden rise in the cost of living in the United States, Luke Tilly, chief economist at the Wilmington Trust, said in a phone interview. But Tilley said he expects inflation to ease in the second half of the year, and the Fed will have to slow the pace of its rate increases “after doing that preload”.

The market may have “outperformed itself in terms of expectations for Fed tightening this year,” says Lauren Goodwin, economist and portfolio strategist at New York Live Investments. She said by phone that the combination of the Fed’s rate hike program and quantitative tightening “could cause a tightening of financial conditions in the market” before the central bank can raise interest rates as much as the market expects in 2022.

Next week, investors will closely watch inflation data for March, according to the Personal Consumption Price Index and Spending. Solway expects personal consumption expenditures inflation data, which the US government is due to release on April 29, to show a rise in the cost of living, in part due to “sharply rising energy and food prices.”

next week Economic calendar Also includes data on US home prices, new home sales, consumer confidence and consumer spending.

Ameriprise’s Saglimbin said he will be monitoring quarterly corporate earnings reports next week from “consumer-facing” tech companies and big tech companies. He said, citing Apple Inc. AAPL, “They Will Be Very Important”
-2.78%And
Meta Platforms Inc. FB,
-2.11%And
PepsiCo Inc. PEP
-1.54%And
The Coca-Cola Co.,
-1.45%And
Microsoft Corp. MSFT,
-2.41%And
General Motors General Motors,
-2.14%
and Alphabet Inc.’s subsidiary of Google, GOOGL,
-4.15%
as examples.

Read: Investors just pulled $17.5 billion from global stocks. Bank of America says they are just getting started.

Meanwhile, FLPutnam’s violin said he was “very comfortable staying fully invested in the stock markets.” He cited lower recession risks but said he favored companies with cash flow “here and now” as opposed to companies with more-growth orientations with earnings far into the future. Alkman also said he likes companies that are preparing to take advantage of higher commodity prices.

“We have entered a more volatile time,” SEI’s Solway warned. “We really need to be a little more careful with how much risk we have to take.”