Some investors fear that the Federal Reserve will tighten interest rates too drastically due to the impact of inflation

Some investors fear that the Federal Reserve will tighten interest rates too drastically due to the impact of inflation

By David Barbuscia and David Randall

(Reuters) – Just months ago, investors were concerned that the Federal Reserve was not fighting inflation hard enough. After several huge interest rate hikes later, some now fear that the Fed will plunge the economy into recession by tightening monetary policy too quickly.

With markets teetering from last week’s strong inflation number, interest rate futures late Friday were pricing in about a 20% chance that the Federal Reserve would raise rates by 100 basis points at its September 21 meeting. This number was out of the question earlier this month, when the market was debating whether the move would be 50 or 75 basis points. Investors are also pricing in higher price hikes down the road, with the final US federal funds rate now at 4.4%.

While earlier in the year some investors criticized the Fed for moving too slowly, many are now more concerned that the frenetic pace of interest rate increases may not allow policy makers to gauge the effects of monetary tightening on the economy, raising the risk of rate hikes too far. .

“We are all afraid of an over tightening and a hard landing scenario, because the Fed has over tightened and caused hard landings more often than it didn’t,” said Jeffrey Sherman, deputy chief investment officer at bond fund DoubleLine.

US data showed the economy appearing to move, despite the 225 basis points in tightening already introduced by the Federal Reserve. It’s easy to find troubling signs, however, from a sharp profit shortfall from delivery company FedEx (NYSE:) the company has blamed for slowing growth to a warning from the World Bank that even a “moderate hit” could send the global economy into recession. .

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DoubleLine CEO Jeffrey Gundlach, who criticized the Fed in June for moving too slowly, told CNBC last week that he worried the Fed could raise interest rates too much. Ray Dalio, founder of Bridgewater Associates, the world’s largest hedge fund, wrote in a recent post on Linkedin that rising interest rates to around 4.5% could sink the stock by about 20%. The Fed’s key interest rate stands at 2.25 to 2.5%.

“There is an increased risk that the Federal Reserve … will exceed interest rate hikes in response to stubbornly high inflation data,” said Stephen Oh, global head of credit and fixed income, and co-head of leveraged finance at PineBridge Investments. “By doing so, they are increasing the risk of a recession rather than the soft landing they are seeking.”

Fears of Fed tightening have already contributed to a 19% drop this year. Global bonds fell sharply, buoyed by a sharp sell-off in Treasuries.

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Federal Reserve Chairman Jerome Powell said price pressure can be reduced without a sharp economic slowdown. But he also stressed that the central bank will be relentless in its fight to stamp out inflation.

“Central banks face sharper trade-offs,” said Jean Boivin, president of the BlackRock Institute (NYSE: Investment Institute). “They have to choose to either live with more inflation or kill growth. There is nothing in between.”

Boivin underestimates the weight of stocks in developed markets and doesn’t find government bonds attractive given that BlackRock expects the Fed to raise interest rates to 4.50% or higher next year.

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“Excessive restriction will be accompanied by material economic pain … pressures on risk and liquidity,” said Daniela Mardarovici, co-chair of multi-sector fixed income at Macquarie Asset Management.

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Andrew Patterson, Vanguard’s chief international economist, thinks the Fed might be better off erring on the side of aggressive behavior, given how stubborn inflation is. However, the company sees https://corporate.vanguard.com/content/corporatesite/us/en/corp/articles/september-2022-investment-economic-outlook.html with a 65% chance of a recession in the next 24 months

Some investors believe the economy may be resilient enough to withstand the more aggressive Federal Reserve. Employment in the US – an important glimpse into the broader economy – grew faster than expected in August.

“The probability of a soft landing has certainly decreased, but it is also possible that the probability of a hard landing has decreased a bit” given the signs of continued demand in the economy, said Steve Bartolini, portfolio manager at T Rowe Price. NASDAQ 🙂 Basic US Bond Strategy.

Market signals have been more worrying, however, including reversals of various parts of the Treasury yield curve – a phenomenon that predates previous recessions. FX pioneer John Taylor, CEO of Taylor Global Vision, is among investors betting there will be more pain in the coming months.

“The stock market is going to be crushed and there will be a recession,” said Taylor, who is betting on further declines in the tech-heavy index. “This is an exaggeration.”

Sherman, of DoubleLine, hopes the Fed will react to signs that growth is slowing, rather than going ahead with full force on raising rates regardless of the consequences.

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“This idea of ​​resilience, and reliance on data, we all want to hear that,” he said. “We don’t want to hear the voice of an autopilot.”

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