Wall St. Week Ahead - Stock rally fuelled by Fed's 'past peakhawkishness'

Wall Street may be seeing some good news once more, with signs of slowing U.S. economic growth boosting hopes that the Federal Reserve won't need to tighten its policy as often as they had previously anticipated.

Wall St. Week Ahead - Stock rally fuelled by Fed's 'past peakhawkishness'

Wall Street may be seeing some good news once more, with signs of slowing U.S. economic growth boosting hopes that the Federal Reserve won't need to tighten its policy as often as they had previously anticipated.

The Atlanta Fed's GDPNow estimate of real GDP growth for the second quarter fell to 1.8% on May 25, from 2.4% the previous week. This was in spite of big misses by retail giants Target Corp (TGT.N), and Walmart Inc (WMT.N). These factors shook their stock prices last week. Atlanta Fed's GDPNow estimate for real GDP growth in the second quarter was 1.8%, down from 2.4% the week before.

A slower economic growth could lead to lower corporate profits and, therefore, soften share prices. In recent weeks, several Wall Street banks warned that there are increasing chances of a U.S. economic recession, as well as an increase in the likelihood of low-growth, high inflation environment known stagflation.

However, investors think that a slowdown in the near term could help the Fed reverse its aggressive monetary policy tilt. This has been a problem for investors, and drove the S&P 500 (.SPX), index to the edge of the 20% decline many consider a bear market.

This week's index gain was 6.6%, snapping a losing streak of seven weeks. However, it is still down about 13% for the entire year. According to data from BofA Global Research, the net weekly inflows into U.S. stocks reached their highest level in 10 years on Thursday.

"It is clear that everyone at Fed is in favor of 50 basis-point interest rate increases for the next two meetings. However, after that, it's not clear what they do. And if there is a sharp downturn in growth, they may have to wait a bit," Anwiti Bahuguna (senior portfolio manager, head of multi-asset strategies at Columbia Threadneedle Investments), who recently increased her allocation to equities, said.

In September, the central bank will stop tightening because of concerns about the impact on inflation. It will leave its benchmark overnight rate at 1.75% to 2.2%, unless financial conditions worsen.

Investors now expect Fed hawkishness to be less. They are pricing in a 35% probability for the Fed funds rate to range between 2.25% - 2.50% after its September meeting. This is down from a 50% probability one week ago according CME.

Already this year, the Fed has raised rates by 75 basis point. Officials were discussing how to guide the economy towards lower inflation and not causing a recession. Continue reading

The emergence of signs of slowing growth has helped to boost Treasury prices. This suggests that investors are more inclined to look at bonds as safety assets than as assets that could be subject to high inflation.

The benchmark 10-year Treasuries yields, which are inversely related to prices, fell to 2.706% on Thursday after climbing to 3.14% this month.

Persson stated that the market was pricing in a slowdown, but not a recession. This makes riskier segments of fixed-income markets, such as high-yield bonds, more attractive.

U.S. data from Friday showed that price increases could be slowing. After a 0.9% increase in March, the personal consumption expenditures price index (PCE) rose 0.2%. This is the smallest gain since November 2020.

Equity buyers should not be encouraged to buy equity if the Fed becomes less hawkish in the long-term. Inflation is at its highest level in decades. Concerns have been raised about impending stagflation. This phenomenon has weighed heavily on all asset types during the supply shocks that occurred in the 1970s.

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