Some investors fear Fed will tighten rates too far as inflation bites

The Federal Reserve Board building on Constitution Avenue is pictured in Washington, U.S., March 27, 2019. REUTERS/Brendan McDermid/File photo

Sept 19 (Reuters) – Just a few months ago, investors worried that the Federal Reserve was not fighting inflation aggressively enough. After several giant rate hikes, some now fear the Fed will plunge the economy into recession by tightening monetary policy too quickly.

With markets reeling from last week’s solid inflation figure, interest rate futures traded Friday night with about a 20% chance that the Fed will raise rates by 100 basis points at its meeting on Friday. September 21st. That number was almost unthinkable earlier this month, when the market was debating whether the move would be 50 or 75 basis points. Investors are also pricing in larger rate hikes ahead, with the terminal rate for US fed funds now at 4.4%. read more

While some investors had criticized the Fed earlier in the year for moving too slowly, many are now more concerned that the frenetic pace of rate hikes is not allowing policymakers to gauge the effects of the monetary tightening in the economy, raising the risks of rates rising too high. .

“We’re all afraid of an overtightening and hard landing scenario, because the Fed has tightened too much and caused hard landings more often than it hasn’t,” said Jeffrey Sherman, deputy chief investment officer at DoubleLine bond fund. .

US data has shown an economy that appears to be humming, despite the 225 basis points of tightening already implemented by the Federal Reserve. Still, it’s easy to find worrying signs, from a serious shortfall in earnings at delivery company FedEx that the company blamed for slowing growth to a World Bank warning that even a “moderate hit” could take the global economy down. to a recession. read more

DoubleLine Chief Executive Jeffrey Gundlach, who in June criticized the Fed for moving too slowly, told CNBC last week that he was concerned the Fed might raise rates too high. 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 sink shares by about 20%. The Fed’s key policy rate stands at 2.25 to 2.5%. read more

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

Concerns about Federal Reserve tightening have already contributed to a 19% drop in the S&P 500 this year. Global bonds have fallen sharply, helped by a sharp sell-off in Treasuries. read more

Fed Chairman Jerome Powell has said that price pressure can be reduced without a sharp economic slowdown. However, he has also stressed that the central bank will be relentless in its fight to stamp out inflation. read more

“Central banks face much steeper trade-offs. They have to choose between living with more inflation or killing growth. There is no middle ground,” said Jean Boivin, director of the BlackRock Investment Institute.

Boivin is underweight developed-market equities and doesn’t find government bonds attractive as BlackRock expects the Fed to raise rates to 4.50% or more next year.

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

Andrew Patterson, senior international economist at Vanguard, thinks it may be preferable for the Fed to err on the side of aggressive action, given how stubborn inflation has been. The signature however goa 65% chance of a recession in the next 24 months.

Some investors believe the economy may be resilient enough to withstand a more aggressive Federal Reserve. US employment, an important snapshot of the broader economy, grew faster than expected in August.

“The probability of a soft landing has definitely decreased, but the probability of a hard landing has probably decreased a little bit as well” given signs of continued demand in the economy, said Steve Bartolini, portfolio manager at T Rowe Price US. Basic bonus strategy.

Market signals, however, have been more worrying, including inversions of various parts of the Treasury yield curve, a phenomenon that has preceded past recessions. Forex trading pioneer John Taylor, CEO of Taylor Global Vision, is among the investors betting there will be more pain in the coming months. read more

“The stock market will get crushed and it will cause a recession,” said Taylor, who is betting on more declines in the tech-heavy Nasdaq Composite Index. “This is an exaggeration.”

DoubleLine’s Sherman hopes the Fed will react to signs that growth is slowing, rather than go ahead with rate hikes regardless of the consequences.

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

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

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