Falling stock markets raise fears of a US recession

Federal Reserve Chairman Jerome Powell | Photo: file/EE

Fears of a sharp rise in US interest rates and a recession rattled global markets on Monday, following the release of higher-than-expected US inflation figures on Friday.

European stocks opened mostly in the red after US inflation hit a new record high in May at 8.6 percent year-over-year, well above analysts’ expectations.

The increase in consumer prices accelerated again last month. These figures caused a sharp drop in the New York Stock Exchange on Friday, 2.73 percent for the Dow Jones and 3.52 percent for the Nasdaq. Asia followed the movement. The Tokyo stock market closed sharply down 3.01 percent and the yen fell to its lowest level against the dollar, which was trading at its lowest point since 1998. Shanghai lost 0.89 percent and Hong Kong fell a 3.07 percent in the last operations.

The Monetary Committee of the Central Bank of the United States (Fed) will meet this Tuesday and Wednesday, and markets are already expecting a 50 basis point adjustment of key interest rates, after a similar increase last month.

But with prices rebounding, more and more analysts are wondering if the Central Bank will not tighten the screw further by triggering a 75-point interest rate hike, an extremely rare move in recent Fed history.

What can happen after the Fed meeting?

America’s highest inflation in four decades would push the Federal Reserve to raise interest rates more aggressively this year, and a recession may not be far off.

Those are the dramatic signs coming from the markets, which on Monday also presented a general increase in yields: 10-year rates reached their highest level since 2011, while their two-year equivalents rose to levels last seen. before the global financial crisis and 30-year yields hit their highest level in more than three years.

The Bloomberg dollar indicator touched peaks last seen early in the COVID pandemic, adding to a backdrop that sparked a spiraling decline in risk assets. Meanwhile, a widely-followed part of the US yield curve has inverted — supported by rising Treasury futures volumes — amid concerns that tighter monetary policy will have a bigger impact on the economy. economic growth.

Data on Friday showed consumer prices accelerated to a 40-year high. The rise in yields and fall in share prices “makes sense in the wake of the staggeringly strong CPI we had on Friday,” Matthew Hornbach, Morgan Stanley’s global head of macro strategy, said on Bloomberg Television.

The arrival of a black swan

Fears that an aggressive pace of monetary policy tightening will push the world’s largest economy into an economic recession are on display as traders pile protection against bearish stocks, bet on ‘Black Swan’ bottom-line funds of the world and buy dollars, among other defensive operations.

The most aggressive US rate hike since 1994 is now seen as almost a done deal and a ‘shock’ as inflation data puts pressure on the Federal Reserve to clamp down on prices, which in turn spurs intermittent slowdown reversals in key parts of the yield curve.

“All the classic recession trades are up for grabs,” said Peter Chatwell, head of global macro strategies trading at Mizuho International Plc.

And it’s that accelerating inflation and slowing growth have raised concerns among World Bank officials that the global economy is entering a period of stagflation, reminiscent of the 1970s. Here’s how those fears play out. in the main markets, in the weakest links.

An indicator of recession in the credit market has jumped higher since 2020 as investors pile into contracts that insure against defaults among the most precarious corporate borrowers.

“Inflation is really the Achilles’ heel of risk markets. This economy will require higher real rates to rein it in and put some downward pressure on inflation,” he added.

Market prices suggested the possibility that the US central bank could implement hikes even larger than the 50 basis point hikes it has already made this cycle.

Traders expect an additional 175 basis point adjustment after the September Fed decision, which would imply an increase of two half points and one 75 basis point, depending on interest rate swaps linked to the dates of the decisions. Federal Open Market Committee rates.

Therefore, all eyes will be on Fed Chairman Jerome Powell’s post-meeting statement and press conference, where the characterization of inflation and long-term forecasts for the federal funds target of the monetary authority, the so-called dot plot, will be fundamental.

The Fed hasn’t raised the rate by three-quarters of a percentage point since 1994, and a tightening of this magnitude is fueling concerns about shrinking consumer spending and business activity. Benchmark inflation-adjusted Treasury yields also rose Monday amid prospects for an even more aggressive Federal Reserve.

“Yields on 10-year Treasury Inflation-Protected Securities rose to around 0.53 percent, the highest since March 2020. Driving real rates higher will be a crucial barometer of true interest costs for corporations, is a key objective of the Fed as it seeks to tighten financial conditions to reduce inflation,” said Morgan Stanley’s Hornbach.

But in addition, the combination of collapsing consumer confidence, unexpectedly intense price pressures and expectations of Fed activism are conspiring to create a particularly toxic cocktail for risk assets, Rabobank strategists including Richard McGuire.

The inversion of the yield curve “resonates with the notion that the need to address elevated price pressures will cause the Fed to drive the economy into recession.” That view is consistent with expectations that the fed it will need to relax the policy again in two years.

The market is already positioning itself for policymakers to respond to the looming slowdown with future rate cuts, pricing in a two-quarter point of easing by mid-2024.

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