Analysis – No relief for battered markets as Fed signals higher rates for longer

Analysis – No relief for battered markets as Fed signals higher rates for longer

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By David Barbuscia and David Randall

NEW YORK (Reuters) – The Federal Reserve is left deadlocked on fighting inflation with little hope that turbulent markets will end this year any time soon, as policymakers point to interest rates rising faster and higher than many investors had expected.

The Fed raised interest rates by an expected 75 basis points and indicated that its policy rate would rise by 4.4% by the end of the year and reach 4.6% by the end of 2023, a much steeper and longer trajectory than the markets had charted.

Investors said the aggressive trajectory points to more volatility in stocks and bonds in a year that has already seen bear markets in both asset classes, as well as risks that tighter monetary policy will plunge the US economy into recession.

โ€œThe reality is starting in the markets regarding the messaging from the Fed and the continuation of this program of rate hikes to get interest rates in a restricted area,โ€ said Brian Kennedy, portfolio manager at Loomis Sales. “We don’t think we’ve seen a peak in yields yet given that the Fed is going to keep moving here and the economy keeps going up.”

Kennedy’s money continues to focus on short-term Treasuries and maintains “high” levels of cash as yields on short- and long-term bonds are expected to rise between 50-100 basis points before peaking.

Stocks fell after the Fed meeting, with a 1.7% drop. Bond yields, which move inversely with prices, have risen, with the two-year yield rising above 4% to its highest level since 2007 and 10-year yields hitting 3.640%, the highest since February 2011. This has left the yield curve more inverted, a signal of the recession that appears in the horizon.

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The S&P 500 is down 20% this year, while US Treasuries have had their worst year in history. These declines came as the Fed has already tightened interest rates by 300 basis points this year.

โ€œRisk assets will likely continue to suffer as investors will pull back and be a little more defensive,โ€ said Eric Sterner, chief investment officer at Apollon Wealth Management.

Sterner said higher yields on US government bonds are likely to continue to weaken the attractiveness of equities.

“Some investors might look at the stock markets and say the risk isn’t worth it, and they might shift more of their investment to the fixed income side,” he said. “We may not see strong returns in the stock markets in the future now that interest rates have normalized somewhat.”

Returns: https://fingfx.thomsonreuters.com/gfx/mkt/klvykawwrvg/Pasted%20image%201663800897972.png

In fact, the average price-to-earnings forward for the S&P 500 was about 14 in 2007, the last time the Fed funds rate was at 4.6%. That compares with the forward P/E multiple of just over 17 today, which suggests stocks could fall further as interest rates rise.

โ€œPowell is drawing a line in the sand and remains very committed to fighting inflation and is unconcerned about spillovers to the economy at this point,” said Anders Persson, chief global fixed income investment officer at Noufen. “We have more volatility ahead and the market will have to reset that reality.”

Think “too conservative”

Investors have piled into assets like cash this year as they seek a haven from market volatility while also seeing an opportunity to buy bonds after the market crash.

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Many believe that higher returns are likely to make these assets attractive to income-seeking investors in the coming months. The shape of the Treasury yield curve, with short-term interest rates standing above longer-term rates, also supports caution. This phenomenon, known as an inverted yield curve, has preceded previous recessions.

โ€œWe are trying to determine which direction the curve is essentially going,โ€ said Charles Carey, MD, senior US fixed income portfolio manager at Xponance, who said his fund was thinking โ€œvery conservativelyโ€ and owning more Treasuries than it had in the past. .

The higher yields on the short end of the Treasury yield curve were attractive, said Peter Baden, CIO of Genoa Asset Management and portfolio manager at US Benchmark Series, a group of US Treasury ETF products. At the same time, higher recession risks have increased the attractiveness of long-term bonds.

He likened Powell’s stance on inflation to that of former Federal Reserve Chairman Paul Volcker, who buoyed high consumer prices in the early 1980s by dramatically tightening monetary policy.

“(Powell said) we’re going to do what it takes. They need to rein in demand and bring that in line with supply. This is a Paul Volcker moment,” he said.

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