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Why stock market investors keep holding back on the Fed’s ‘pivotal’ talk – and what it will take to hit the bottom




Market timing has been a vexing question for investors since shares began dropping nearly 25% in January of this year. The correct answer will likely depend on whether or not the Federal Reserve is following through with its plans to raise the benchmark interest rate to 4.5% or higher, as predicted by market-based indicators and the latest set of Federal Reserve expectations.

Global markets are on the brink of a possible crisis in emerging markets as a result of higher interest rates and the US dollar at a 20-year high, a slump in the housing market due to rising mortgage rates, or the collapse of a financial institution due to Worst bond market chaos in a generation.

We see: The massive US dollar is wreaking havoc in the markets: why it’s so hard to stop.

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


Fed Efforts Are Already Failing Markets almost daily.

The continued volatility in the markets makes it difficult to be sure that buying opportunities will arrive, said Bill Sterling, global strategist at GW&K Investment Management.

Peak interest rates are important for stocks

A look at how the Fed conducts monetary policy compared to its own expectations provides good reason to be skeptical about the expectations surrounding when the Fed will switch to monetary easing.

It’s important to remember that stocks often reacted favorably when the Fed went back to cutting interest rates. Dating back to August 1984, it is the S&P 500 Index It rose on average more than 17% in the 12 months (see chart) that followed a peak in the federal funds rate range, according to Sterling in GW&K and Federal Reserve data.


Federal Reserve, a set of facts

The chart also shows the Nasdaq Composite and Dow Jones Industrial Average have risen sharply in the year after the Federal Reserve raised interest rates to peak levels in previous monetary tightening cycles over the past nearly 40 years.

The same is true for bonds, which have historically outperformed after the Fed’s rate-raising cycle reached its climax. Sterling said yields have historically fallen, on average, by a fifth of their value, in the 12 months after the Fed’s benchmark interest rates peaked.

Still, one factor that distinguishes the modern era 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 weakness of the US economy, combined with fears of a crisis erupting somewhere in global markets, complicates the monetary policy outlook.

But as investors watch markets and economic data, Sterling said “lagging” measures such as the US CPI and PCE are not nearly as useful as “forward” metrics, such as break-even spreads created by Treasury inflation-protected securities, Or survey data like the University of Michigan Inflation Expectations Index.


The market is caught between these forward-looking and encouraging signs that inflation may go down next year as seen in [Treasury inflation-protected securities] Sterling said.

Stocks started last week and the fourth quarter with a two-day rally after major indexes ended September 30 at their lowest levels since 2020. Those gains faded over the course of the week as Fed officials and economic data undermined investor expectations about a potential Fed. “pivotal” away from his program of sharp interest rate increases. Stocks ended the week higher, but with the Dow Jones Industrial Average

up just 2% from its September 30 low, while the S&P 500

trimmed its weekly high to 1.5% and the Nasdaq Composite

Offer only 0.7%.


Read: Scattered hopes about the Fed’s pivot turn into a sense of dread in financial markets

Neil Kashkari, President of the Federal Reserve Bank of Minneapolis And the Federal Reserve Governor Christopher Waller They said policy makers had no intention of giving up on the rate hike plan, in what was just the latest round of hawkish comments made by top Federal Reserve officials.

However, some on Wall Street are paying less attention to what senior Fed officials say and more to market-based indicators such as Treasury spreads, relative movements in sovereign bond yields, and credit default spreads, including Swiss credit spreads.
+ 13.05%

Crescat Capital’s Costa said he sees a growing “disconnection” between the state of the markets and the Fed’s aggressive rhetoric, with the prospect of a crash growing by the day.

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


He expects the explosion to 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 into the gold bond market – even though the Bank of England is preparing To continue raising interest rates to fight inflation

We see: Bank of England official says $1 trillion pension fund investment could have been wiped out without intervention

But before that happens, he expects fixed-income trading to become as disorganized as it was during the spring of 2020, when the Federal Reserve had to intervene to avoid the bond market crash at the start of the coronavirus pandemic.

Just look at the difference between Treasury yields compared to junk bond yields. “We still have to see this rally driven by default risk, which is a sign of a completely dysfunctional market,” Costa said.

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


A simple look in the rear-view mirror shows that the Fed’s plans to raise interest rates rarely work as well as the central bank expects. Take last year, for example.

The median forecast for the level of the federal funds rate in September 2021 was just 30 basis points one year ago, according to the Fed’s survey of forecasts. These forecasts turned out to be off by about three percentage points.

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

Looking forward to next week

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

US inflation data will be front and center in the markets, with the September CPI due on Thursday. On Friday, investors will get an update from the University of Michigan on its Consumer Confidence Survey and Inflation Expectations Survey.


Inflation data will be scrutinized particularly closely as investors grapple with signs that the US labor market may already be beginning to weaken, according to Krishna Guha and Peter Williams, US economists at Evercore ISI.

Show the jobs report for the month of September on Friday The US economy created 263,000 jobs Last month, the unemployment rate fell to 3.55 to 3.7%, but job growth slowed from 537,000 in July and 315,000 in August.

But will inflation show signs of peaking or slowing its rise? Many fear that Crude oil production quotas cuts imposed by OPEC + Earlier this week it could push prices higher later in the year.

Meanwhile, the federal funds futures market, which allows investors to bet on the pace of Fed rate hikes, expects to raise rates by another 75 basis points on November 3.

Moreover, traders expect the fed funds rate to hit 4.75% in February or March at 4.75%, according to the Federal Reserve. FedWatch Tool.


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