The next big shoe to drop in the financial market: Inflation that fails to respond

Traders, investors and strategists are adding another factor to the list of reasons why financial markets could be more volatile in the next three to four months: Fed rate hikes are unlikely to push inflation.

Wednesday’s price action reflected continued concerns in the stock market, with all three major indicators suffering sharp losses. Dow Jones Industrial Average DJIA,
The S&P 500 SPX fell more than 1,000 points in the afternoon.
Investors had a reasonable way to get Fed Chairman Jerome Powell’s scathing remarks and a “soft” landing from Tuesday that his assurance was revalued as government bonds fell more than 3% in a flight to safety.

Read: Why are stocks falling? The fragile ‘bear market’ bounce underscores investors’ fears

Equities have been volatile for the past two weeks since the Fed decided to raise 50 basis points on May 4, its biggest increase in 22 years. A day after the Fed’s move, the Dow fell nearly 1,100 points and the Nasdaq Composite Index comp.
Signs of panic sales on Wall Street have dropped the worst daily percentage since 2020. All three major indices have suffered double-digit losses this year as a result of stock sales.

Financial markets that have not yet fully considered US inflation, 8.3% as of April but still close to a four-decade high, may fail to respond to Fed rate hikes this summer, according to traders, strategists and investors. Typically, it takes six to nine months, or even two years, for the economy to increase rates. But that policy gap can be lost in the easy money accustomed markets for many years and become more uncomfortable day by day. Although the Fed’s efforts to shrink its nearly $ 9 trillion balance sheet add an extra layer to the financial situation, it did not begin until June 1.

“The significant impact of the price increase is likely to be felt by the end of this year,” said David Petrosenelli, a senior New York-based Insperex trader who has underwritten over $ 670 billion in securities. Meanwhile, the Fed is “losing room” or public confidence, “quite quickly because there’s really no light at the end of the inflation tunnel”.

“We’re in the first or second inning of market volatility because it’s not just what the Fed is doing, it’s not what the Fed isn’t doing,” he said by phone, referring to policymakers’ decision not to shrink the next portfolio. There is growing skepticism about Powell and the Fed’s current game plan. Windows or corridors are shrinking day by day for soft landings, and there is a growing scenario where inflation will not decrease significantly in the next few months of the Fed hikes. “

As of Wednesday, traders of derivatives-like instruments known as fixing were setting prices at five more annual headline inflation rates above 8% based on consumer-price index reports from May to September. This is mainly due to high energy costs and it reflects a significant shift where expectations were expected from May 6, when traders forecast inflation to fall below 8% in June.


The table above reflects the projected profit at the annual headline CPI rate compared to the previous year. The 8% -plus reading is now being pencilled within five months, although Powell reiterated on Tuesday that a half-percentage point interest rate hike at both the Fed’s June and July meetings remained the baseline case.

Just two weeks ago, on May 6, traders expected inflation to fall below 8% soon:


In a comment at a Wall Street Journal event on Tuesday, Powell sought to reassure the public that there was an “honorable path” to a “soft” landing for the economy, even if there was some “pain” ahead. If necessary, he said, the Fed would not hesitate to push past inflation at a “neutral level of understanding” – or at a level where policy does not increase or slow down economic growth. Powell said the Fed will continue to raise rates until there is “clear and credible evidence” that inflation is declining. The Fed’s rate target currently stands at 0.75% to 1%.

For now, the financial markets have four different views on inflation, says Jim Vogel, an interest rate strategist at Memphis-based FHN Financial.

The bond market is “leaning towards the Fed’s assumption of success, although it is uncertain about the timing.” In a phone interview, Vogel said stock markets “almost wish the Fed would not succeed” because of the perception that high inflation could help some stocks surpass. The “commodity confusion” and the forward inflation market have “split between the Fed which may be successful, but not for an extended period of time.”

The problem, he said, is that while the Fed rate hike has reduced demand in “margins”, policymakers are “going to be ineffective” in addressing the following issues: structural demand for workers; Russia’s war against Ukraine and China’s zero-tolerance policy on Kovid-19 disrupt supply chains; And businesses need to redirect their “time, energy and money” to regionalize some of their investments and activities.

This dynamic “accelerates inflation in the short term, although in the long run inflation can resolve itself,” Vogel told MarketWatch. Meanwhile, “there is more room for equity selling as investors penalize stocks with international exposure and financial markets risk insufficiency and mild panic.”

Whatever the outcome of inflation, according to Vogel, the Treasury curve will continue to be flat.
And 10-year rate TMUBMUSD10Y,
Possibly reversed by 20 to 30 basis points at some point.

Depending on this collapse of the global geopolitical situation, “We can look forward to an environment that would easily last until 2023. The Fed policy was dormant in the first half of 2024.”

Read: Wild stocks and bonds taste more volatile due to rising risks to US inflation

Petrosinelli of InspereX sees a possibility that the 10-year rate could move to 4%, 2.9% from Wednesday’s level, in the second or third quarter. As of afternoon trading, Treasury yields were broadly lower as investors jumped on government bonds, shrinking the spread between the 2- and 10-year rates to 23 basis points in a worrying signal about the outlook.

Walgreens Boots Alliance Inc. WBA,
Coca-Cola Co. KO,
And Walmart Inc. WMT,
Dow was among the biggest losers, while retailer Target Corporation shares of TGT,
After dropping more than 25% on Wednesday when it missed a big gain in deepening market-wide pessimism.

“We’re a little bit more optimistic about the rise in inflation in the fall, and we don’t see any downturn in the United States,” said Jay Hatfield, chief investment officer at Infrastructure Capital Advisors in New York, a manager at exchange-traded funds and hedge funds. Oversees assets of about $ 1.18 billion. He sees 10 years left is about 3% and the stock will remain rangebound.

But in a non-base case where the market suspects that the Fed is ineffective — that it has a 20% to 30% disagreement on whether it is effective 10 the 10-year rate could rise to 3.5% or 4% and “in the S&P 500 SPX. Our estimate of fair value,
It will drop to 3,500 “from current levels near 3,935 on Wednesday, Hatfield said via phone.

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