50% cut more likely after Fed rate hike
- A “stubborn” Federal Reserve has increased the likelihood of a prolonged recession, according to Peter Cecchini of Axonic Capital.
- Indeed, the Fed could cause an economic boost that would lead it to cut interest rates sooner than expected.
- “The 1970s nearly 50% decline scenario for the S&P 500 becomes all the more likely,” Cecchini said.
The decision to raise interest rates by 75 basis points this week only increases the chances of a prolonged economic recovery.
and a sell-off in the stock market, according to Peter Cecchini of Axonic Capital.
That’s because the Fed is just beginning to tighten financial conditions aggressively as data begins to show inflation slowing. This scenario can cause a major political boost that leads to economic hardship for millions of people, according to Cecchini.
“Stifling domestic demand with rate hikes too late could now lead to a protracted recession, particularly because politics operates with a three to nine month lag on the economy,” Cecchini said, adding that the stubbornness of the Fed waiting so long to raise interest rates could lead to an expensive policy see-saw.
Indeed, while the Fed attempts to control inflation by reducing consumer demand for goods and services, it is actually supply-side constraints and rising commodity prices that are source of most inflation, an aspect of the economic equation over which the Fed has little influence.
That’s why she would have paid dividends for the Fed to reign in consumer demand by starting its cycle of interest rate hikes earlier than it did, because that would have helped rein in demand before supply chain constraints and rising oil prices add fuel to the fire.
Instead, the Fed is embarking on a fast and furious interest rate hike path that will likely include two back-to-back 75 basis point interest rate hikes in July, which followed an interest rate hike in interest of 25 basis points and 50 basis points in March. and May, respectively. At the end of 2021, the Fed had only planned to raise interest rates once in 2022.
All of this means that stock investors could still see a lot more trouble ahead, even after factoring in the S&P 500’s more than 20% drop year-to-date.
“Unfortunately, the risk aversion scenario we formulated in late 2021 is starting to materialize, and the 1970s nearly 50% decline scenario for the S&P 500 becomes all the more likely,” Cecchini said.
A 50% drop in the S&P 500 from its January peak would send the index to the 2,400 level, which represents the potential downside of more than 30% from current levels.
A double whammy of shrinking valuations and lower earnings forecasts “is likely to happen,” Cecchini said, causing further declines in the market. Despite recent market volatility, a 40-year inflation record and rising interest rates, Wall Street analysts have not budged in lowering their 2022 corporate earnings estimates.
This indicates that there is still room for investors to be disappointed with earnings, which could fuel further selling pressure, as earnings generally drive stock prices over the long term.