By David Randall and Davide Barbuscia
NEW YORK (Reuters) – Federal Reserve Chairman Jerome Powell’s reassuring message after the central bank’s monetary policy meeting may not soothe frazzled U.S. stock and bond investors as uncertainty over the path of inflation takes focus on upcoming figures strengthened.
While Powell acknowledged on Wednesday a lack of recent progress in the Fed’s fight against rising consumer prices, he reiterated the view that rates are likely to fall this year.
That came as a relief to those worried that the Fed would expect more rate hikes after three straight months of stronger-than-expected inflation.
Still, some investors believe the market is less likely to take Powell at his word this time, after a much-touted easing in December was followed by several months of upside surprises in inflation and employment. A new set of robust economic data could revive fears of rate hikes and fuel further turbulence in stocks and bonds, they said.
Market swings on Wednesday reflected investor nervousness, with the S&P 500 closing 0.3% lower after a rally that saw the index rise more than 1% during Powell’s news conference. Yields on 10-year government bonds, which move opposite to prices, fell by almost 10 basis points.
“If the Fed wants to be as data-dependent as they claim to be, every data point will be scrutinized by the market to see if it means higher for an extended period of time or the possibility of rate hikes being back on the table,” said Steve . Hooker, portfolio manager at Newfleet Asset Management.
The first major data point comes Friday, with the closely watched U.S. employment report. More evidence of a stronger-than-expected labor market could further undermine forecasts about how much the Fed will cut rates this year. Investors are now pricing in cuts of around 35 basis points in 2024, down from more than 150 basis points in January.
Data on everything from inflation to retail sales will follow later in the month.
While stocks are still close to the record highs hit earlier this year, their rally is faltering as expectations of rate cuts have faded in recent weeks, sending the S&P 500 to its worst performance since September last month.
Bond investors have been struggling for months, with 10-year government bond yields rising 70 basis points this year.
“Market expectations have swung from one extreme to another,” said Paul Mielczarski, head of global macro strategy at Brandywine Global. He is overweight five- and seven-year Treasuries versus his company’s benchmark, anticipating that the Fed will eventually cut rates further than the market expects.
“Naturally, the market is a bit cautious… waiting for the data to confirm the Fed’s underlying view that inflation can fall to 2 percent without the need for a recession,” he said.
Some investors fear that the Fed will no longer be able to cut interest rates, even though this is still relatively early in the year. Blerina Uruci, chief US economist at T Rowe Price, believes the Fed will need at least three months of weaker-than-expected data to have enough confidence to cut rates.
“If we don’t see the weakness in private sector rents translating into the data (consumer prices), how much more confident should we be that the deflationary push will continue to happen?” Uruci said. “I don’t think this reversal in the inflation trend will happen soon enough,” Uruci said.
Others worry that increased interest rates will soon put pressure on some U.S. companies. Jonathan Duensing, head of U.S. fixed income at Amundi US, prefers investment-grade corporate bonds, in part because he believes a prolonged period of high interest rates could cause some stress on lower-rated companies.
He was also bullish on government bonds likely to benefit from a flight-to-quality bid in the event of “a stumble in the economy going forward,” he said.
That does not mean that investors have completely given up hope of interest rate cuts. Tony Welch, chief investment officer at SignatureFD, believes much of the rise in inflation earlier this year was due to commodity prices, which soared partly on concerns about a spreading conflict in the Middle East .
Oil prices fell to their lowest level in seven weeks on Wednesday due to a surprise increase in US crude inventories and the prospect of a ceasefire between Israel and Gaza.
Welch is bullish on small-cap stocks, which he believes will benefit from an easing interest rate environment as long as the economic outlook remains favorable.
“I’m pretty sure the Fed is right and they are correctly assessing the inflation tea leaves,” he said.
(Reporting by David Randall and Davide Barbuscia; Editing by Ira Iosebashvili)
