The rally in the United States has hit a bump. Stocks wobbled again last week as the rally earlier in the year, led by rallies from 2022 losers, ran into resistance from expected higher interest rates from the Federal Reserve following readings of persistent inflammation and little sign that growth is collapsing.
Economists at several major Wall Street banks, including Goldman Sachs, Bank of America and Citigroup, raised their forecasts for the possible terminal interest rate to 5.25% and 5.50%, bringing them in line with the federal funds futures market. Deutsche Bank now expects a ceiling at 5.6%, half a percentage point higher than its previous estimate, and one of the highest forecasts.
According to CME Group’s FedWatch, the futures market expects three more quarter-point hikes, from the current 4.50% to 5.25%, at the March, May and June meetings of the Federal Open Market Committee. The outlook change was the sum of the last quarter-point move, with a 57.5% chance of a high of at least 5.25% to 5.50% in June, as of last Friday. This figure is higher than the 41.8% of a week ago and the 4% of a month ago.
The change in these probabilities reflects a series of recent economic data showing higher-than-expected gains in employment and retail sales for January, along with less easing of inflation at the consumer and producer levels.
Two Federal Reserve district chairpersons, Loretta Mester of Cleveland and James Bullard of St. Louis, also opined last week that the last Fed meeting justified a half-point rate hike, rather than quarter. The meeting concluded on February 1, before the more bullish than expected economic data was released.
Yet neither of these hawks has a vote at the Fed this year. However, the panel will lose a prominent ‘dove’ with the departure of Lael Brainard, vice president of the Fed, to address the National Economic Council of the White House.
The CPI reference
Among the most notable data is the consumer price index for January, which rose 0.5% more than expected, bringing the year-on-year increase to 6.4%. “More importantly, the recent slowdown in the shorter term in retail price increases has come to a halt,” says Matthew Luzzetti, chief US economist at Deutsche Bank; the annualized increase in the last three months was 4.6%, compared to 4.4% in December. “The moderation of the pandemic rise in the prices of raw materials seems to have come to an end,” says the expert. A scheme that Dallas Fed President Lorie Logan also scathingly demonstrated in a speech last week: “Supply chains can’t bounce back twice.”
“Much of the rally earlier in the year had also been driven by a largely unrecognized increase in global liquidity,” says Citi global markets strategist Matt King. “Even as the Federal Reserve was reducing its balance sheet (also known as quantitative tightening), shares of the European Central Bank, the Bank of Japan, and the People’s Bank of China were adding $1 trillion to global liquidity,” King writes.
At the same time, the impact on bank reserves of the Fed’s cut in its holdings has been largely offset by changes to the Treasury bill and so-called reverse repurchase agreements. However, says King, most of this momentum is over: “As of now, liquidity seems to be drying up, which will likely hurt risky assets, including equities.”
Last week, the main averages ended mixed, but far from their 2022 highs reached on February 2. That was the day after the last FOMC meeting, which raised hopes that the Fed’s rate hikes were nearing completion. It was also the day before news of a 517,000 job gain in January suggested otherwise. “Further near-term interest rate hikes are likely to hamper equities and other risky assets as long as inflation remains stubborn,” says King.