The stock market tumbled this past week as investors finally decided it was time to prepare for the worst-case scenario—a Federal Reserve-induced recession.
S&P 500 index
dove 2.8%, while the
Dow Jones Industrial Average
dropped 1.9% and the
On first glance, the news flow didn’t seem bad enough to warrant such declines. Weekly jobless claims remained below 200,000 for a ninth consecutive week, the longest such streak since 1969, while housing starts topped consensus expectations. IHS Markit’s Composite Purchasing Managers’ Index came in well below expectations, but was still above the 50 level that indicates an economy is growing. Those numbers suggest the U.S. economy is decelerating, something the stock market might have weathered—except for the fact that it still seems to be growing too fast for the Fed.
The market was actually doing OK until Thursday, but then Fed governors started talking. Fed chief Jerome Powell talked the consensus—that the Fed’s benchmark interest rate would have to be raised by half a point. His focus, however, was in doing whatever it takes to cool inflation, and it didn’t help that St. Louis Fed President James Bullard started talking up a 75-basis-point rate hike.
Bullard hasn’t often been seen as leading the way on Fed policy, and BofA Securities economist Ethan Harris argues that “his call for a possible 75 [basis point] hike makes sense, but it will take time and more data to convince the committee.” Maybe not too much time, though, as the odds that the Fed will have raised interest rates by 1.25 percentage points by its June meeting—a half-point hike and a three-quarter-point hike—have jumped to 94%, according to the CME FedWatch tool, up from 28% on April 14.
That’s too hawkish for the stock market. The S&P 500 had been trying to stabilize, with value stocks attempting to rise as growth stocks, which are often, though not always, hurt by higher rates, slid. But if the Fed wants to slow growth even more than it already has—the Atlanta Fed’s GDPNow tool points to economic growth of just 1.3% during the first quarter—and with risks to growth from Russia’s invasion of Ukraine still rising, value stocks, particularly those dependent on a strongish economy, won’t be able to do well, either. “Just a week or so ago the narrative was shifting, with investors embracing the idea that financial conditions had tightened enough to gradually slow growth,” writes Dennis DeBusschere, president of 22V Research. “[The] recent string of firm U.S. data increases the risk that rates need to increase until something breaks.”
And a break might be the most likely outcome. In a report this past week, Deutsche Bank Group Chief Economist David Folkerts-Landau warned that the Fed might have to raise interest rates far higher than expected, perhaps as high as 5%, well above the firm’s baseline view of 3.6%. And it will need to act fast to prevent even higher inflation from getting embedded in expectations, forcing it to raise rates even higher and forcing a deeper slowdown. “Prepare for a hard landing ahead,” he writes.
Will the last bull please turn out the light?
Write to Ben Levisohn at [email protected]