The Fed’s relief rally is a false dawn for inflation-afraid strategists

(Bloomberg) – The collective sigh of relief in the markets after Federal Reserve Chairman Jerome Powell pushed back on speculation the size hikes could be short-lived.

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The concern is that without firm action, markets face a toxic combination of persistently high inflation and slower growth.

While the Fed raised rates by 50 basis points, the most since 2000, and signaled similar moves in the coming months, Powell said 75 basis points was “not something the committee is considering. actively”, stimulating a rally in stocks and bonds.

Traders had increasingly bet that the FOMC would opt for an even bigger rate hike to stifle the highest inflation in decades, a move that would also have increased the risks of pushing the economy into recession.

The S&P 500 index had its best day since May 2020. Treasuries rallied, with yields on two-year bonds falling 14 basis points. The dollar has gone down.

Here are some early reactions from investors and strategists:

Policy limits

Nancy Davis, founder of Quadratic Capital Management:

“The focus is now on the additional 200 basis points of rate hikes expected for the rest of the year. These increases are already taken into account. We wonder why the market thinks the Fed hikes will stop inflation. We believe that monetary policy can do little to calm inflation in the short term. We see inflation being fueled by massive government spending, supply chain disruptions and, most recently, Russia’s invasion of Ukraine.

Unintended consequences

David Page, head of macroeconomic research at AXA Investment Managers:

The market reaction “was interesting and highlighted the difficulties in gauging the required magnitude of future policy tightening. Even as the Fed chief was seen as responding to market expectations for a rate hike this year and galvanizing the broader economy for the effect of rate hikes, financial markets appeared to be reacting to the fact that the Fed was not considering hikes of 0.75% – which was little more than a risky case – and lowered their expectations.

“This marked easing in financial conditions was unlikely to be what the Fed hoped for or expected from its press conference. Whether it reflects a myopic focus on 75 basis point rate hikes or a more considered fear of a economic slowdown, easier financial conditions increase the chances of further Fed rate hikes to come.

bull escalation

Ian Lyngen, Head of US Rates Strategy at BMO Capital Markets:

“We were encouraged by the response to the bullish steepening in rates and the sector’s two-year rally of 2.85% before the chairman took the podium to less than 2.60% following his remarks then that the most extreme price assumptions have made their way out of valuations.”

“The steepening has room to run and we are comfortable letting the price action unfold over the next few sessions.”

With a path for the balance sheet trickle mapped out, “we suspect the process will fade into the background in terms of providing new marketable information.”

Don’t rule out the mega hike

James Knightley, Chief International Economist, and Padhraic Garvey, Regional Research Manager, Americas, at ING Financial Markets:

“Market prices are not particularly aggressive relative to history. That doesn’t seem particularly aggressive given the current state of the economy.

“Although the Fed probably won’t admit it, we’re confident they will be looking closely at the impact on long-term inflation expectations after the FOMC.”

“The 10-year inflation expectation is roughly tolerable below a handful of 3%. The risk, however, is that inflation expectations exceed 3%. If that happened, the arguments for a 75 basis point hike in June would pile up. The immediate reaction was muted, both on real rates and inflation expectations, but we must continue to monitor this important space.

“The FOMC’s focus on fighting inflation and anticipated rate hikes continues to point to dollar support through the summer months.”

dovish surprise

Jeff Klingelhofer, Co-Head of Investments at Thornburg Investment Management:

“I was surprised to see a mildly dismissive dovish statement on inflation. In their hearts and minds, the Fed clings to the idea of ​​transient inflation – they just can’t say it out loud. sometimes it feels like the Fed is super hawkish with spontaneous responses, but their tone changes to more accommodating in official communications I believe the Fed still thinks a lot of their job is They could rise more aggressively if their concerns about inflation are so high.

High-flying acts

Stephen Miller, investment strategist at GSFM:

“Thanks to demonstrated complacency about the magnitude and dynamics of inflation through 2021, engineering a ‘first-best’ solution may now elude the Fed. He is now engaged in the most delicate of central bank high-flying acts.

“Despite a more aggressive approach from the Fed and temporary relief reflected in financial markets, they remain in a volatile phase as they assess the Fed’s success in bringing inflation under control without risking substantial economic dislocation.”

Prioritize raw materials

Alexander Saunders and Citigroup Inc. strategists:

“Commodities are outperforming at this point in a hiking cycle. Equities are starting to perform again mid-cycle after initial indigestion, while credit remains under pressure. Bonds should not be bought until the very end of the cycle. Generally speaking, the up cycles favor commodities and are in line with the underweights in bonds and credit.

Expect big swings

Steven Englander, Head of G-10 FX Research at Standard Chartered Plc:

“Today’s change in tone is consistent with our expectation that inflation and activity will slow as 2022 progresses, ultimately resulting in a significantly lower Fed Funds path and USD level. However, until the trend of slowing growth is well established, the ups and downs in the data could produce big swings in expectations and the tone of the Fed’s comments.

Rethinking Fixed Income

Rebecca Felton at Riverfront Investment Group:

“I think it was a collective sigh of relief across the board today.” Powell was measured and avoided pressing the panic buttons.

“We think the worst is over for bond investors.” Riverfront is underweight fixed income, but “will start to rethink that positioning here in the short term and those will be more attractive asset classes.”

Equity fund

Tina Teng, Markets Analyst at CMC Markets:

“I see that a bottom has been reached in the broader equity markets, as the Fed’s projections for its rate hike roadmap could not be more aggressive than markets had anticipated. US inflation is also showing signs of peaking. Powell’s comment on a “soft” landing for the economy indicates a relaxation of the tightening approach.

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