By David Randall and Davide Barbuscia
NEW YORK (Reuters) – Federal Reserve Chairman Jerome Powell’s reassuring message following the central bank’s monetary policy meeting may not reassure weary U.S. stock and bond investors as uncertainty over the path of inflation takes the focus for the upcoming dates.
Although Powell acknowledged Wednesday that there has been no recent progress in the Fed’s fight against rising consumer prices, he reiterated his view that interest rates are likely to fall this year.
That came as a relief to those who feared the Fed might consider further rate hikes after three straight months of stronger-than-expected inflation.
Still, some investors believe the market will take Powell less at his word this time around, after December’s much-touted trend was followed by several months of positive inflation and employment surprises. Another set of robust economic data could revive fears of interest rate hikes and fuel further turmoil in stocks and bonds, they said.
Wednesday’s market swings reflected investor jitters, with the S&P 500 closing 0.3% down after rallying during Powell’s news conference to gain more than 1%. Benchmark 10-year Treasury yields, which move inversely to prices, fell nearly 10 basis points.
“If the Fed wants to be as data dependent as it claims, every data point will be scrutinized by the market to see if it means higher interest rates for an extended period of time or the possibility that rate hikes are on the table again,” said Steve Hooker, Portfolio manager at Newfleet Asset Management.
The first key data point comes on Friday with the closely watched US jobs report. Further evidence of a stronger-than-expected labor market could further undermine forecasts of how much the Fed will cut interest rates this year. Investors are currently pricing in cuts of about 35 basis points in 2024, compared to more than 150 basis points in January.
Data on everything from inflation to retail sales will follow later in the month.
Although stocks are not far from their record highs reached earlier this year, their rally has faltered as interest rate cut expectations have been pushed back in recent weeks, causing the S&P 500 to post its worst performance since September last month.
Bond investors have been struggling for months, with the 10-year Treasury yield rising 70 basis points since the start of the year.
“Market expectations have flipped from one extreme to the other,” said Paul Mielczarski, head of global macro strategy at Brandywine Global. He is overweight five- and seven-year Treasury bonds relative to his firm’s benchmark because he expects the Fed will ultimately cut interest rates more than the market expects.
“Of course the market is a little cautious … waiting for the data to confirm the Fed’s fundamental view that inflation can fall to 2 percent without the need for a recession,” he said.
Some investors fear that time is running out for the Fed to cut interest rates, even though it is still relatively early in the year. Blerina Uruci, chief U.S. economist at T Rowe Price, believes the Fed needs to have at least three months of weaker-than-expected data to feel confident enough to cut rates.
“If we don’t see the weakness in private sector rental prices reflected in the (consumer price) data, how much more confidence should we have that the deflationary impulse will continue to occur?” Uruci said. “I don’t think this reversal in the inflation trend will happen quickly enough,” Uruci said.
Others fear that increased interest rates will soon put pressure on some US companies. Jonathan Duensing, head of U.S. fixed income at Amundi US, favors investment-grade corporate bonds, in part because he believes a prolonged period of high interest rates could lead to stress among lower-rated companies.
He was also bullish on government bonds, which would likely benefit from a flight to quality if “the economy stumbles in the future,” he said.
That doesn’t mean investors have completely given up hope of rate cuts. Tony Welch, chief investment officer at SignatureFD, believes much of the rise in inflation earlier this year can be attributed to commodity prices, which soared in part because of worries about a widening conflict in the Middle East.
Oil prices fell to a seven-week low on Wednesday due to a surprise increase in U.S. 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 confident that (the Fed) is right and that they’re reading the inflation tea leaves correctly,” he said.
(Reporting by David Randall and Davide Barbuscia; Editing by Ira Iosebashvili)