What stock market investors can expect from US Fed rate hike spree | The Financial Express

What stock market investors can expect from US Fed rate hike spree

Here’s a look at recently announced PCE and ISM-PMI reports and their impacts on inflation, employment, economic prospects, central bank tightening and earnings.

What stock market investors can expect from US Fed rate hike spree
Further downside in equities may occur alongside falling yields, as demand destruction and contracting earnings take center stage.

By José Torres

Economic updates and Federal Reserve Chairman Jerome Powell’s comments paint a somewhat favorable outlook for the war on inflation, but investors are reacting to the developments with mixed emotions as they examine the demand picture. Here’s a look at recently announced PCE and ISM-PMI reports and their impacts on inflation, employment, economic prospects, central bank tightening and earnings.

Powell hinted at continued rate increases, additional balance sheet reductions and a likely higher-than-anticipated terminal rate, but investors focused on his comments about the central bank moderating the pace of rate hikes and the Chairman’s belief in the ongoing possibility of a soft landing.

This optimism and accompanying equity rally were sustained by the Core PCE Index showing a slight moderation in inflation.

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Sometimes, however, good news is followed by bad news, at least in the eyes of investors who reacted negatively to ISM Purchasing Managers’ Index (PMI).

The PMI contracted for the first time since the spring of 2020 against the backdrop of weak new orders, employment and prices. While the ISM has dampened investor sentiment by pointing to future declines in corporate earnings, its weakness implies that the Federal Reserve’s rate hikes are weakening demand for products and services, thereby providing additional fodder for optimism that the central bank will slow its rate hikes.

The PCE and ISM reports are providing mixed signals as investors grapple with focusing on either slower inflation and lower yields or slower demand and reduced earnings.

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In my view, a failure to bring down services inflation and job openings would result in inflation being stuck at 3.5 to 4%, a level too high relative to current market pricing.

For now, however, investors will need to grapple with whether inflation is coming down due to declining demand or due to rising efficiencies, economic indicators point to the former. Further downside in equities may occur alongside falling yields, as demand destruction and contracting earnings take center stage while Powell and the Fed rest in the bullpen for a few innings.

(Author is Senior Economist at Interactive Brokers)

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First published on: 02-12-2022 at 18:45 IST