Could Overly Easy Credit and a Soaring Stock Market Threaten the Fed’s Fight Against Inflation?
As the Federal Reserve kicks off its two-day meeting, stocks continue to rally, with the S&P 500 ending January with a gain of 6.2%. The tech sector performed even better, with a 9.2% increase in the same period. Meanwhile, interest rates have fallen, with the benchmark 10-year Treasury yield settling at 3.5% after closing December at 3.9%.
BlackRock’s Chief Investment Officer for Global Fixed Income, Rick Rieder, anticipates Fed Chair Jerome Powell to express his views in a more hawkish manner. Rieder predicts that if Powell’s speech is indeed hawkish, the market has already priced it in. However, a non-hawkish outlook could spark another market boom.
In the futures market, Fed funds futures indicate a terminal rate of less than 5%. Moreover, these futures suggest that investors anticipate the Fed to change direction and cut rates by 25 basis points by the end of 2023.
Jim Caron, Head of Macro Strategies for Global Fixed Income at Morgan Stanley Investment Management, agrees with Rieder’s assessment. Caron believes that the Fed’s downsizing of its rate hikes alone will be perceived as a dovish move. Before the 50 basis point hike in December, the central bank raised rates by 75 basis points in four consecutive moves.
Caron suggests that Powell aims to preserve the validity of the 5% to 5.25% terminal rate forecast, while at the same time, he recognizes the declining trends in housing prices, auto sales, retail sales, and wage inflation. Despite the latter being above comfort levels, it is still coming down.