Analysis: The Fed is feeding Wall Street hopes for a soft landing, although recession fears linger

February 2 (Reuters) – A more muted-than-expected message from Federal Reserve Chair Jerome Powell is likely to further boost hopes of a slowdown in rate hikes and a so-called economic soft landing, which have fueled a strong rebound in US stocks .

For weeks, hopes that easing inflation and slowing growth will allow the Fed to backtrack on its tightening monetary policy outlook have buoyed stocks and other risk assets after a brutal 2022.

Many on Wall Street remain convinced that a widely anticipated recession will roil markets again sometime this year. However, bullish investors took note of Powell’s comments at the end of Wednesday’s monetary policy meeting, when he acknowledged progress in the fight against inflation and was reluctant to act against the rally in stocks and bonds.

“At this point, the market has welcomed the fact that a few more 25 basis point hikes are basically minor adjustments,” said Alessio de Longis, senior portfolio manager at Invesco Investment Solutions. “The light at the end of this currency cycle is coming.”

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De Longis is banking on further gains in many of the asset classes that have thrived in recent weeks, including equities, emerging markets and higher-yielding bonds.

The S&P 500 was up more than 1% on Wednesday and is now up more than 7% for the year. Benchmark 10-year US Treasury yields, which move inversely with prices, fell after the session and are down more than 40 basis points in 2023.

Certainly, Powell gave little hint that the Fed was on the verge of deviating from its rate hike path after announcing a widely expected 25 basis point rate hike. He said “a few more” rate hikes were likely in store.

However, Garrett Melson, portfolio strategist at Natixis Investment Managers Solutions, said the market is pleased at the lack of a “hawkish bounce” in the broader rally in risk assets, which could complicate some concerns about containing inflation. Also encouraging for investors was Powell’s repeated reference to disinflation – a falling rate of inflation.

The monthly rate was negative in December, when consumer prices were 0.1% lower than in November. It was the first fall since May 2020.

“I think they see a way for you to achieve that soft landing, that Goldilocks scenario,” he said.

SKEPTICISM

Many investors nonetheless heard a less dovish message from Wednesday’s meeting, with many skeptical that policymakers would be able to slash the highest inflation in decades without hurting the economy.

“We believe that the ultimate path to bringing inflation fully back to target almost inevitably requires a recession, albeit a short and shallow one,” said Kristy Akulian, senior strategist at BlackRock’s iShares investment strategy team.

Banks and asset managers that have made repeated calls for recession in recent weeks include BlackRock, Wells Fargo and Neuberger Berman.

Meanwhile, a key part of the Treasury yield curve, which inverted in March last year for the first time since 2019, remained deep in negative territory, with shorter-dated bond yields outperforming longer-dated bonds, a time-honoured recession signal.

Others said while futures markets priced in the Fed’s interest rate peaking at around 4.88% in June – a peak lower than the 4.91% recorded before the meeting – and falling in the second half of the year, rate cuts would likely come that quickly only if the economy went into recession.

The Fed has forecast that it will raise interest rates to between 5% and 5.25% and stay there until at least the end of the year, and Powell insisted on Wednesday that rate cuts are nowhere in sight.

“Do people think that (rate cuts) will be a reaction to falling inflation or something more dramatic in terms of the economic slowdown? I would suspect the latter,” said Fran Rodilosso, VanEck’s head of portfolio management for fixed income ETFs.

Nonetheless, some investors are comfortable with the more dovish scenario, especially if inflation slows further. Ed Al-Hussainy, senior rates strategist at Columbia Threadneedle, is beginning to unhedge in the futures markets that would pay off if rates hit 5%.

“We have a tremendous shift in the Fed’s willingness to look at both sides of the inflation data and this time to acknowledge that disinflation is occurring,” he said. “It sounds like they’re very exhausted.”

Reporting by Davide Barbuscia and Lewis Krauskopf; Writing by Ira Iosebashvili; Editing by Megan Davies

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