Fed action: This time could really be different
THE US Federal Reserve’s decision to raise rates by the widely-expected 50 basis points last week sparked a large and immediate “relief rally’’ in US stocks and a new mantra making the rounds on Wall Street that “50 is the new 25’’.
Perhaps more of a relief was that “75 will not be the new 50’’, given the Federal Open Markets Committee (FOMC)'s forward guidance that it is “not actively’’ considering raising rates by 75 basis points, at least not yet.
That the rally proved shortlived however, should come as no surprise. Fed meetings have typically acted as de-risking events, especially in a market that had already fallen sharply ahead of the FOMC. Once the initial bounce was completed, markets quickly turned to the overriding concern – the likelihood of an impending US recession and the very real fear that this time could be different.
Notwithstanding the Fed’s statement that it thinks it has a good chance of achieving a soft landing, investors would be well-advised to be cognisant of the fact that for the first time in more than a decade, there is real concern on Wall St whether the Fed can bail out the economy – and by extension markets – like it has repeatedly in the past.
A big worry is that unlike previous periods of significant market and economic uncertainty when the Fed could slash rates to reflate the economy and stabilise asset prices, it now cannot do the same. Instead, it is now embarking on a determined tightening cycle - markets are now pricing in three more 50-point hikes before the end of the year, whilst the 10-year Treasury yield, which started the year at 1.5 per cent, has now doubled.
As a result, April proved to be one of the worst months for US equities in years – the Dow Jones Industrial Average lost 3.9 per cent and the S&P 500 fell 8.8 per cent to record its largest monthly loss since the onset of the Covid-19 pandemic in March 2020. Meanwhile, the tech-heavy Nasdaq Composite, which is particularly sensitive to rising bond yields, plunged 13.3 per cent, its worst monthly performance since the US sub-prime crisis of Oct 2008. Furthermore, as at end-April, the Nasdaq had moved into bear market territory, its 24 per cent loss from its high exceeding the 20 per cent qualifying threshold.
Global equities now face a confluence of headwinds – monetary tightening by the Fed as it tries to rein in runaway inflation, Covid-19 lockdowns in China, ongoing war in Ukraine that is pushing commodity prices up, and a collapsing bond market where the US Treasury yield curve inverted at least twice in March.
This combination has prompted forecasts of an impending recession. For instance, although Goldman Sachs in April said it expects the US to avoid a contraction partly because households are in better shape than in previous economic cycles, an overheated job market has nonetheless raised the odds. The investment bank has assigned a 15 per cent chance of a recession in the next 12 months, and 35 per cent in the next two years.
However, CNBC surveys last week found that more than half of US economists and investment professionals expect the Fed to fail in its mission to engineer a “soft landing” for the economy, and that 8 in 10 small business owners expect a US recession this year. It certainly looks like this time could really be different.
