The picture for U.S. equities and bonds is becoming even more gloomier as predictions for how quickly the Federal Reserve will need to hike rates soar due to hot inflation. After the Fed hiked rates by 225 basis points this year, investors have been debating for weeks whether the entire scope of its hawkishness has been included into market prices. Many investors also expect the Fed to raise rates by an additional 75 basis points at its meeting next week.
The argument that the central bank will need to be much more hawkish than anticipated in the coming weeks is strengthened by the hotter-than-expected inflation figure released on Tuesday, which crushed the prices of stocks and bonds. Investors are being forced to prepare for a possibly greater dosage of Fed tightening, which has jolted asset prices all year.
According to the widely followed CPI data, consumer prices in the US surprisingly increased in August, climbing at an annual rate of 8.3%, not far from the four-decade high achieved in June.
According to this analysis, the Federal Reserve must really tighten monetary policy even more, according to Matthew Miskin, co-chief investment strategist at John Hancock Investment Management. “Markets are generally in fairly bad shape,”
Fed funds futures are now pricing in a roughly 36% possibility that the Fed will increase its benchmark rate by a full percentage point next week. Analysts at Nomura, who predicted a 100 basis point increase in September on Tuesday, concur with this assessment. Analysts have also increased their predictions for how much the central bank will increase rates in the upcoming months.
The markets responded quickly; on Tuesday, the tech-heavy Nasdaq plunged 5.2% and the benchmark S&P 500 lost 4.3%, marking the worst one-day declines for both indices since June 2020. The benchmark 10-year Treasury note’s yields, which move counter-cyclically to bond prices, increased to 3.46%, the highest level in over three months.
A market already dealing with uncertainty on a number of fronts, from concerns about whether the central bank’s inflation war could trigger a recession to the ripple effects of increasing real rates on asset prices, is not in favor of growing expectations for the Fed to be more hawkish.
The Fed will also increase the liquidation of its balance sheet to $95 billion per month starting in September, a move that some investors fear could increase market volatility and hurt the economy. The market might “at a minimum,” according to Phil Orlando, chief equities strategist at Federated Hermes, “challenge” its mid-June low of around 3,600. He claimed that the market’s assessment of the inflation issue was wholly incorrect. “Today … pushed equities investors to confront reality after a major wake-up call.
Some people find even the time of year to be a cause for worry: the Stock Trader’s Almanac reports that the S&P 500 has seen its worst monthly performance in September since 1950, falling an average of 0.5% in that month. The index was now down 0.6% for the month and down nearly 17% for the year.
The S&P 500’s recovery, which saw a 17% increase from its mid-June low, was further hampered by Tuesday’s inflation news. The stock market has already lost around half of those gains.
Furthermore, it dispelled some of the hopes that the Fed would soon be able to “pivot” to loosening monetary policy, which sometimes supported risky markets.
According to this data point, Matt Peron, director of research at Janus Henderson Investors, “Any anticipated Fed turn isn’t in front of us.” “With the peak hawkishness story over the previous couple of weeks, the market got a bit ahead of itself.”
Investors who had relied on a combination of the two asset types to temper market falls risk further suffering if stocks and bonds continue to tumble.
According to BofA Global Research, so-called 60/40 portfolios, which invest 60% of their assets in equities and 40% in bonds with the hope that drops in one asset class will result in increases in the other, are down more than 12% for the year thus far, their worst performance since 1936.
Of course, following a turbulent year thus far, many investors have been bracing for further volatility. In September, fund managers lifted cash balances to 6.1%, the highest level in more than 20 years, according to a monthly study by BofA Global Research that was made public on Tuesday.
Ed Al-Hussainy, senior global rates strategist at Columbia Threadneedle, said: “The crucial question is at what point does the Fed develop enough confidence that they’ve done enough. It’s evident that we’re not near that stage today.” “I believe there is still more harm to be done on the risk asset side.”