Some investors fear the Fed may tighten rates too much as inflation bites

By Davide Barbuscia and David Randall

(Reuters) – Just months ago, investors feared the Federal Reserve was not fighting inflation aggressively enough. Several giant rate hikes later, some now fear that the Fed could plunge the economy into recession by tightening monetary policy too quickly.

With markets reeling from last week’s robust inflation numbers, interest rate futures late Friday priced around a 20% chance that the Fed would raise rates by 100 basis points during its September 21 meeting. This figure was almost unthinkable at the start of the month, as the market debated whether the move would be 50 or 75 basis points. Investors are also anticipating bigger rate hikes in the future, with the US federal funds terminal rate now at 4.4%.

While earlier this year some investors criticized the Fed for moving too slowly, many are now more concerned that the breakneck pace of rate hikes will not allow policymakers to assess the effects of monetary tightening on the economy, increasing the risks that they raise rates too much. .

“We’re all scared of the over-tightening and the hard-landing scenario, because the Fed has over-tightened and caused hard landings more often than it has,” said Jeffrey Sherman, deputy chief investment officer of the DoubleLine bond fund.

US data showed an economy that appears to be buzzing, despite the 225 basis point tightening already announced by the Fed. Still, worrying signals are easy to find, ranging from a severe shortfall at delivery company FedEx, which the company has blamed on slowing growth, to a warning from the World Bank that even a “moderate blow “could plunge the global economy into a recession.

DoubleLine chief executive Jeffrey Gundlach, who in June criticized the Fed for moving too slowly, told CNBC last week he was worried the Fed was raising rates too much. Ray Dalio, founder of Bridgewater Associates, the world’s largest hedge fund, wrote in a recent Linkedin post that a rate hike to around 4.5% could send stocks down around 20%. The Fed’s key rate is between 2.25 and 2.5%.

“There is a growing risk that the Fed … overshoots rate hikes in response to stubbornly high inflation data,” said Steven Oh, global head of credit and fixed income, co-head of funding at leverage at PineBridge Investments. “By doing so, they are increasing the risk of a recession rather than the soft landing they seek to achieve.”

Fears of Fed tightening have already contributed to a 19% drop in the S&P 500 this year. Global bonds fell sharply, helped by a strong sell-off in Treasuries.

Terminal Velocity https://graphics.reuters.com/USA-MARKETS/znpnewmrmvl/chart.png

Fed Chairman Jerome Powell said price pressure could be eased without a sharp economic downturn. He also stressed, however, that the central bank will be relentless in its fight to stamp out inflation.

“Central banks are faced with much more acute trade-offs. They must choose to either live with more inflation or kill growth. There is nothing in between,” said Jean Boivin, head of BlackRock Investment Institute.

Boivin is underweight developed market equities and does not find government bonds attractive given that BlackRock expects the Fed to hike rates to 4.50% or more next year.

“Excessive tightening would lead to material economic hardship… risk and liquidity stress,” said Daniela Mardarovici, co-head of multi-sector fixed income at Macquarie Asset Management.

The Fed’s Next Move The Fed’s Next Move https://graphics.Reuters.com/GLOBAL-MARKETS/xmpjoaydnvr/chart.png

Andrew Patterson, senior international economist at Vanguard, thinks it might be better for the Fed to err on the side of aggressive action, given how stubborn inflation is. The company nevertheless sees https://corporate.vanguard.com/content/corporatesite/us/en/corp/articles/september-2022-investment-economic-outlook.html a 65% probability of a recession over the next 24 months.

Some investors believe the economy may be resilient enough to withstand a more aggressive Fed. Employment in the United States – an important snapshot of the economy as a whole – rose faster than expected in August.

“The probability of a soft landing has certainly gone down, but the probability of a hard landing has also probably gone down a bit” given the signs of continued demand in the economy, said Steve Bartolini, portfolio manager for the T Rowe Price US. Basic bond strategy.

Market signals were more worrying, however, including inversions of various parts of the Treasury yield curve – a phenomenon that predated past recessions. Currency trading pioneer John Taylor, CEO of Taylor Global Vision, is among investors betting there will be more pain in the coming months.

“The stock market will be crushed and cause a recession,” said Taylor, who is betting on further declines in the tech-heavy Nasdaq Composite Index. “It’s exaggerated.”

DoubleLine’s Sherman hopes the Fed will react to signs of slowing growth, rather than forging ahead with its rate hikes, whatever the consequences.

“This idea of ​​flexibility, of data dependency, we all want to hear it,” he said. “We don’t want to hear the autopilot.”

(Reporting by Davide Barbuscia and David Randall; Additional reporting by Matt Tracy, Nell Mackenzie, Carolina Mandl and Vincent Flasseur; Editing by Ira Iosebashvili and Diane Craft)

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