Analysis-Markets sigh with relief after Powell speech, but more turbulence likely ahead

By Davide Barbuscia and David Randall

– A rally in US stocks and bonds powered ahead after a speech by Federal Reserve Chairman Jerome Powell on Wednesday, but some investors believe that a looming recession could cap gains in two asset classes.

Although asset prices have been battered by Fed rate hikes this year, momentum has been on the bulls’ side in recent weeks. The S&P 500 rose nearly 14% from October lows while the yield on the benchmark 10-year Treasury, which tracks rates, fell to nearly 3.6%, from a 15-year high of 4.3% in earlier this year.

The immediate reaction to Powell’s speech on Wednesday reflected the recent optimistic mood among investors. The S&P 500 surged more than 3% after Powell said the Fed may slow the pace of its rate hikes as soon as December, though he cautioned there was little clarity on how high. prices should eventually rise as the central bank fights the worst. outbreak of inflation in decades.

However, some market participants believe that the weekly increase in stocks and bonds must fail, a fate that has met with some other rebounds this year. The S&P 500 is down 14.4% year to date.

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The upcoming employment and inflation reports – due on December 2 and December 13, respectively – could become near-misses if they fail to show that the rate hikes already given by the central bank this year have sufficiently cooled the economy.

US consumer prices rose below expectations in October, supporting the view that inflation has eased.

Going forward, some of Wall Street’s biggest banks are now predicting that the Fed’s monetary policy tightening will lead to a recession next year.

The inversion of the US Treasury yield curve – a signal that precedes previous advances – has weighed on recession forecasts. Yields on two-year Treasuries recently surpassed those on 10-year Treasuries by their largest margin since the dot com bubble.

“Our view is that this is not a sustainable rally,” said Jake Jolly, senior investment strategist at BNY Mellon. “The chances are there will be a recession next year, and that will put pressure on risk assets like equities.”

‘HAWKISH ADMINISTRATIONS

Analysts at Citi wrote that the rise in risk asset prices on Wednesday was due to “hawkish expectations built up before Powell’s comments, the certainty of a slowdown in a 50bp rate hike pace , and the absence of a clear rise in the hawkish message. was given in early November FOMC meeting.”

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Their takeaway: Powell shifted his focus to non-housing service inflation, which is more difficult to slow down, “given labor markets are still very tight.” On Wednesday, Powell noted that core price measures for services remained elevated. Data released earlier in the day showed there were about 1.7 more job openings for every unemployed person.

“Powell seems to have come in today and expressed that they are confident that the brakes are working,” said Jake Schumeier, a portfolio manager at Harbor Capital Advisors, referring to the Fed’s spate of jumbo 75 basis point rate hikes aimed at slowing down in the economy.

In the longer term, however, “the market seems to be positioned for a slowdown, to limit the increase once we get past seasonal trends at the end of the year,” he said.

Among the banks predicting a decline is Bank of America, whose analysts see a broadly flat S&P 500 as markets face “recessionary shock.”

The BlackRock Investment Institute said on Wednesday that while a recession is likely, “equity valuations do not yet reflect damage ahead.” They also underweight long-term government bonds, betting that central banks are unlikely to stop cutting rates in a recession if inflation remains high.

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To what degree economic concerns will impact the market on near-term bullish sentiment remains to be seen. The S&P 500 on Wednesday traded above its 200-day moving average for the first time since April, a move seen by some investors who view the chart as a sign of bullish equities. in the short term.

In options markets, traders appear to be more concerned with not losing out on further gains in stocks than guarding against future declines. The one-month moving average in daily bearish trading pits contracts against bullish S&P 500 index-tracking calls SPDR S&P 500 ETF Options confidence is at its lowest since January 2022, according to Trade Alert data.

“The path of least resistance since the last inflation number is higher,” said Sameer Samana, senior global market strategist at Wells Fargo Investment Institute. “There will be upside momentum in place until something stops it.”

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