In the more optimistic corners of Wall Street, promising inflation data over the past week or so suggests that the Fed may deliver a soft landing after all.
However, no such belief prevails among top money managers, who are betting that an economic downturn filled with still-very high price pressures will determine next year’s trading.
With a closely watched section of the Treasury yield curve sending fresh signs of recession, stagflation is the agreed view among 92% of respondents in Bank of America Corp.’s latest survey of fund managers.
Meanwhile, Citigroup Inc. A “Powell push” scenario in which the Fed would have to raise even if growth drops, while BlackRock Inc. doesn’t see it. No possibility of a soft landing in either the United States or Europe.
The bearish stance comes even as recent data on employment as well as consumer and producer prices – together with decent corporate earnings – suggest that the US central bank may in fact succeed in its high-cost mission of increasing borrowing costs without a business cycle collapse.
For now, however, the professional investment class will need to see more conclusive evidence of a benign shift in economic trajectory before materially changing its defensive position across the battered world of stocks and bonds.
“Central banks will tighten further and push economies into a mild recession, but they will stop rising — before they do enough to bring inflation down to target — as the damage from rate hikes becomes more apparent,” said Wei Li, chief global investment analyst. in BlackRock.
Lee sees slowing US growth, lower earnings and higher price pressures, justifying the company’s lower weight in developed market stocks and bonds, despite its willingness to put some cash back into corporate credit. Its position is supported by investors in Bank of America, who overwhelmingly see stagflation on the horizon. The company’s latest survey shows that it has historically been underweight in stocks – with the share of technology at its lowest level since 2006 – and overweighted in cash.
The pessimism contrasts with the bout of enthusiasm sparked by last week’s US inflation report suggesting that price pressures may be peaking. This intensifies the debate about whether the Fed has room to ease its rate hikes.
The latter was summarily dismissed by a review of monetary officials this week. Among the more hawkish, St. Louis Fed President James Bullard said policymakers should raise interest rates to at least 5%-5.25% to curb inflation. It came after San Francisco Federal Reserve Bank President Mary Daley said a pause in the hiking cycle is “off the table,” while Kansas City Fed President Esther George warned that the Fed could find it increasingly difficult. In taming inflation without causing a recession.
As higher interest rates ignite bear markets in stocks and bonds, the Federal Reserve has shifted from a friend in bull times to a new adversary. Nor does a pacifist political trend seem likely any time soon. Citi, for example, is promoting the idea of a “Powell push,” with Jerome Powell’s central bank being forced to raise growth rates to lower inflation rates in the face of persistent inflation in the future.
“We classify the environment as stagflationary,” according to Citi strategist Alex Saunders. He recommends selling US stocks and credit, and buying commodities and bonds in the Powell Push scenario.
Invesco is also treading cautiously, tilting exposure to defensive stocks with excessive bets in US Treasurys and investment grade credit.
“Signaling more ‘risk on’ would be signs the Fed is close to ‘pausing’ rate hikes,” said Christina Huber, chief global market strategist at Invesco.
Even Morgan Stanley’s Andrew Sheets — who holds a minority view that core inflation will fall to 2.9% by the end of 2023 — isn’t ready to take the risk just yet given the possibility of an economic slowdown. However, he points to the mid-1990s as a reason for optimism. In that time, an era characterized by high inflation as interest rates soared, stocks and Treasury bonds were finally able to make significant gains.
Bears say soft landings are rare. But they do happen,” Sheets wrote in his forecast for next year.
The new Impact Report weekly newsletter will examine how ESG news and trends are shaping the roles and responsibilities of today’s CEOs – and how they can better overcome these challenges. Subscribe here.