Why stock-market investors keep falling for Fed ‘pivot’ talk — and what it will take to put in a bottom

Market timing has been a lingering question for investors since shares began falling roughly 25% in January of this year. The right answer likely depends on whether or not the Federal Reserve follows through on plans to raise its benchmark interest rate to 4.5% or higher, as forecast by market-based indicators and the latest batch of projections of the Fed.

Global markets are bracing for the possibility of an emerging markets crisis as a result of the highest interest rates and a US dollar at a 20-year high, or a slump in the housing market due to the ‘rising mortgage rates or the collapse of a financial institution due to the worst bond market turmoil in a generation.

I will see: A raging US dollar is wreaking havoc on markets: why it’s so hard to stop.

Fears that the Fed could cause something in the global economy or financial system to “break” have inspired some to question whether the Fed can successfully whip up inflation by raising interest rates at the most aggressive pace of the decades without causing collateral damage.

The Fed’s efforts are already destroying the markets on an almost daily basis.

Continued volatility in the markets makes it difficult to determine when buying opportunities might come, said Bill Sterling, global strategist at GW&K Investment Management.

Peak interest rates matter for stocks

A look back at how the Fed has managed monetary policy compared to its own projections provides good reason to be skeptical about expectations about when the Fed will again shift toward an easing monetary policy.

It’s important to remember that stocks have often reacted positively when the Fed has cut interest rates again. Dated August 1984, the S&P 500 Index has risen an average of more than 17% in the 12 months (see chart) that followed a peak in the fed funds rate range, according to Sterling at GW&K and data from the Fed.


The chart also shows that the Nasdaq Composite and Dow Jones Industrial Average rose sharply in the year after the Fed raised interest rates to their highest levels in previous cycles of monetary policy tightening in roughly the last 40 years .

The same goes for bonds, which have historically performed better after the Fed’s rate-hiking cycle peaked. Sterling said yields historically retreated, on average, by a fifth of their value in the 12 months after the Fed’s benchmark rates peaked.

Yet another factor that differentiates modern times from the persistent inflation of the 1980s is the high level of geopolitical and macroeconomic uncertainty. As Tavi Costa, portfolio manager at Crescat Capital, said, the weakening of the US economy, plus fears of a crisis breaking out somewhere in global markets, are complicating the outlook for monetary policy.

But as investors look to markets and economic data, Sterling said that “back-to-back” measures, such as the U.S. consumer price index and the personal consumption expenditure index, are not as useful as indicators. futurists”, such as equilibrium differentials. generated by Treasury inflation-protected securities or survey data such as the University of Michigan’s Indicator of Inflation Expectations.

“The market is caught between these futurist and encouraging signs that inflation could fall next year, as seen in the [Treasury inflation-protected securities] returns,” Sterling said.

Stocks started last week and the fourth quarter with a two-day rally after major indexes ended Sept. 30 at their lowest level since 2020. Those gains faded over the course of the week as the Fed officials and economic data lowered investor expectations around a possible Fed. “walks away” from its program of aggressive interest rate hikes. Stocks ended the week higher, but with the Dow Jones Industrial Average DJIA,
down just 2% from its Sept. 30 low, while the S&P 500 SPX,
trimmed its weekly gain to 1.5% and the Nasdaq Composite COMP,
advanced by only 0.7%.

Reads: Dashed hopes of a Fed pivot are turning into a sense of fear in financial markets

Minneapolis Fed President Neel Kashkari and Fed Governor Christopher Waller have said policymakers have no intention of abandoning their plan to raise interest rates, which only be the latest round of false comments made by senior Federal Reserve officials.

However, some on Wall Street are paying less attention to what senior Fed officials are saying and more attention to market-based indicators such as Treasury spreads, relative movements in sovereign bond yields and spreads on credit defaults, including those of Credit Suisse Inc. CS. ,

Costa at Crescat Capital said he sees a growing “disconnect” between the state of the markets and the Fed’s hawkish rhetoric, with the odds of a downturn growing by the day.

Because of this, he is waiting for “the other shoe to drop,” which could be a major turning point for the markets.

He predicts a blowout will eventually force the Fed and other global central banks to back off their policy-tightening agenda, as the Bank of England did briefly last month when it decided to inject billions of dollars of liquidity in the gold market, although the BoE. prepares to continue raising interest rates to fight inflation

look: Bank of England official says $1 trillion in pension fund investments could have been wiped out without intervention

But before that happens, expect fixed-income trading to become as messy as it was during the spring of 2020, when the Fed was forced to intervene to prevent a bond market collapse at the start of the coronavirus pandemic.

“Just look at the spread between Treasury yields versus junk bond yields. We’ve yet to see this rise driven by default risk, which is a sign of a totally dysfunctional market,” Costa said.

see: Cracks in financial markets fuel debate over whether the next crisis is inevitable

A simple look in the rearview mirror shows that the Fed’s plans to raise interest rates rarely play out the way the central bank expects. Take last year for example.

The median projection for the level of the federal funds rate in September 2021 was just 30 basis points a year ago, according to the Fed’s survey of projections. Turns out, those projections were cut by nearly three full percentage points.

“Don’t take the Federal Reserve at its word when trying to anticipate the direction of Fed policy over the next year,” Sterling said.

Looking forward to next week

Looking ahead next week, investors will get more information on the state of the US economy and, by extension, the Fed’s thinking.

US inflation data will top the markets, with September’s consumer price index due out on Thursday. On Friday, investors will get an update on the University of Michigan’s survey of consumer sentiment and its survey of inflation expectations.

According to Krishna Guha and Peter Williams, two U.S. economists at Evercore ISI, inflation data will be particularly closely watched as investors grapple with signs that the U.S. labor market may be starting to weaken .

Friday’s September jobs report showed the U.S. economy gained 263,000 jobs last month, with the unemployment rate falling to between 3.55 and 3.7 percent, but employment growth slowed from 537,000 in July and 315,000 in August.

But will inflation show signs of rising or slowing down? Many fear that the cuts in crude production quotas imposed by OPEC+ earlier this week could push prices higher later this year.

Meanwhile, the Fed funds futures market, which allows investors to bet on the pace of Fed rate hikes, is forecasting another rate hike of 75 basis points on Nov. 3.

Beyond that, traders expect the federal funds rate to top 4.75% in February or March, according to the Fed’s FedWatch tool.

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