Investors will watch for another gauge of U.S. inflation in the week ahead after the stock market was rattled by the Federal Reserve ramping up its hawkish tone and suggesting large interest rate hikes are coming to get an overheating economy under control. 

“We’re probably seeing peak hawkishness right now,” said James Solloway, chief market strategist and senior portfolio manager at SEI Investments Co., in a phone interview. “It is no secret that the Fed is way behind the curve here, with inflation so high and so far only one 25 basis-point increase under their belt.”

Fed Chair Jerome Powell said April 21 during a panel discussion hosted by the International Monetary Fund in Washington that the central bank isn’t “counting on” inflation having peaked in March. “It is appropriate in my view to be moving a little more quickly,” Powell said, putting a 50 basis-point rate hike “on the table” for the Fed’s meeting early next month and leaving the door open to more outsize moves in the months ahead.

U.S. stocks closed sharply lower after his remarks and all three major benchmarks extended losses Friday, with the Dow Jones Industrial Average booking its largest daily percentage drop since late October 2020. Investors are grappling with “very strong forces” in the market, according to Steven Violin, a portfolio manager at F.L.Putnam Investment Management Co.

“The tremendous economic momentum from the recovery from the pandemic is being met with a very rapid shift in monetary policy,” said Violin by phone. “Markets are struggling, as we all are, to understand how that’s going to play out. I’m not sure anyone really knows the answer.”

The central bank wants to engineer a soft landing for the U.S. economy, aiming to tighten monetary policy to fight the hottest inflation in about four decades without triggering a recession.

The Fed “is partly to blame for the current situation as its exceedingly accommodative monetary policy over the last year has left it in this very tenuous position,” wrote Osterweis Capital Management portfolio managers Eddy Vataru, John Sheehan and Daniel Oh, in a report on their second-quarter outlook for the firm’s total return fund.  

The Osterweis portfolio managers said the Fed can raise the target fed funds rate to cool the economy while shrinking its balance sheet to lift longer maturity rates and contain inflation, but “sadly, implementation of a dual-pronged quantitative tightening plan requires a level of finesse that the Fed is not known for,” they wrote.

They also raised concern over the Treasury yield curve’s brief, recent inversion, where shorter-term yields rose above longer-term yields, calling it “a rarity for this stage of a tightening cycle.” That reflects “a policy error,” in their view, which they described as “leaving rates too low for too long, and then potentially hiking too late, and probably too much.”

The Fed last month hiked its benchmark interest rate for the first time since 2018, raising it by 25 basis points from near zero. The central bank now appears to be positioning to front-load its rate hikes with potentially larger increases.

Source by: marketwatch