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Stressed-out stock and bond markets are finding it’s a lot harder getting anyone’s attention with threats as big as war and spiraling food costs commanding the world’s attention.
Once feared as vigilantes whose every twist was reason for policy makers to rethink their course, markets are finding their tantrums elicit little notice from governments bent on punishing Russia and reeling from the hottest inflation in 40 years.
While most people agree that’s how it should be, given the gravity of the threats, it opens the door to steeper and steeper dislocations as solutions on both fronts prove elusive. In late 2018, it took about three weeks of serious turmoil to force Federal Reserve chief Jerome Powell to bow to the market’s message. No such sympathy is forthcoming now — even with the S&P 500 stuck in correction territory days before the central bank’s rates liftoff.
That’s a very different backdrop from the past. In four major tightening cycles since 1990, none has started anywhere near this close to a 10% drawdown in stocks.
“The inflation they’re trying to tame is not your typical business-cycle inflation. This is an extraordinary circumstance,” says Art Hogan, chief market strategist at National Securities. “That’s why everyone says the Fed put is behind us.”
Equity bulls hoping for pity have another uncomfortable fact to consider. Even while investors may spy turmoil for the economy in months and even years down the road, none exists now, at least in terms of a slowdown in growth. While Goldman Sachs sees the risk of a recession as high as 35% in the coming year, economists surveyed by Bloomberg say the U.S. economy will expand 3.6%.
That’s ample cover for Powell, who has repeatedly said the economy is expanding enough to weather the interest rates needed to rein in inflation. In February, U.S. consumer prices increased 7.9% from a year ago, the biggest jump since the early 1980s, Labor Department data showed Thursday.
Stocks shuddered in the aftermath as Treasury yields lurched higher. The S&P 500 finished the week nearly 3% lower, despite posting its biggest rally in nearly two years on Wednesday.
While February’s inflationary surge was the largest since 1981, the numbers have yet to reflect the 14% increase in oil prices and other commodities so far in March. As the U.S. and other nations levy sanctions against Russia for its invasion of Ukraine, 12-month inflation figures are likely to remain “very uncomfortably high,” according to Treasury Secretary Janet Yellen.
In Ukraine, “what we’re seeing is an atrocity,” Yellen said in a CNBC interview Thursday. “We’ve designed these sanctions to have the maximum impact on Russia while mitigating fallout for everyone else, including the U.S. But it’s not realistic to think that we can take actions of this magnitude without feeling consequences ourselves.”
In addition to higher energy and food prices, investments in U.S. assets are also facing blowback. While energy stocks have soared alongside oil prices, every other S&P 500 sector is nursing losses this year, dragging the benchmark down more than 12% from its all-time highs. Technology shares — at the mercy of spiking Treasury yields — have been hit the hardest, with the Nasdaq 100 sinking almost 20% from its peak.
Even the corporate bond market, which had been relatively resilient to the upheaval, is starting to show strains. Yields on BBB rated bonds — the lowest rung of investment-grade — have widened to roughly 1.69 percentage points above Treasuries, reflecting the stress.
That’s put the BBB spread precipitously close to 2 percentage points. Crossing that threshold has prompted the Fed to either cut rates, keep them at zero or pause a hiking campaign in data going back to 2000, according to DataTrek Research co-founder Nick Colas.
“There is a clear call and response between BBB spreads and monetary policy, and this slice of the U.S. investment grade corporate bond market is beginning to flash a warning sign to the FOMC,” Colas wrote in a report this week. “It is too early to say chair Powell and the FOMC are about to do another monetary policy about-face, like January 2019, but that time may be coming very soon indeed.”
However, there doesn’t appear to be any urgency among policy makers to dial back their tightening plans. Powell told lawmakers last week that he backed a quarter-point hike at next week’s meeting, while leaving open the possibility of a half-point hike down the road.
Depending on the duration of Russia’s war in Ukraine and to what degree financial conditions tighten, that stance could tilt dovish in the weeks and months to come. Still, given the labor market’s robust recovery and sky-high inflation, the policy makers “need to move” to satisfy the central bank’s dual mandate, according to Truist Advisory Services’ Keith Lerner.
“The most they can likely do at this point is not be as aggressive,” said Lerner, the firm’s co-chief investment officer and chief market strategist. “Them not going as fast isn’t the same as in the past, when they could come in and cut rates and slash rates and just provide a lot of liquidity, because they’re constrained by the inflation environment.”
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