The S&P 500 Index dropped more than 1% Wednesday after the latest consumer price index topped economists’ forecasts, renewing concerns that the Fed will delay any cuts. The technology-heavy Nasdaq 100 Stock Index slumped 1.2% as Treasury yields soared to a fresh year-to-date high near 4.5%.
However, US equities are likely to continue their uptrend based on good economic news, which Zervos, the bank’s chief market strategist, expects to swamp discussions about keeping rates higher for longer.
Continued strength in US economic data and signals from the Fed that there’s no rush to ease monetary policy have prompted investors to recalibrate their expectations for the timing and frequency of interest rate cuts. After Wednesday’s inflation reading, traders are now signaling that they anticipate policymakers dialing back rates just twice this year starting in September.
Zervos said market expectations at the start of 2024 for six cuts by December was “almost as silly” as pricing in two cuts at the start of last year.
While he sees hefty cuts as wishful thinking, he also argues that policy is still less restrictive than traditional measures. He points to the Fed’s balance sheet as a sign “the stimulative vestiges of quantitative easing are still with us.”“The market has been predicting doom on the economy because of high rate levels for a very long time,” Zervos wrote. “The missing link for the true economic storyline has been stimulative central bank balance sheets.”Minutes from the Fed’s last policy meeting released Wednesday also showed that policymakers “generally favored” slowing the pace at which they’re shrinking the central bank’s asset portfolio by roughly half.
Moreover, Zervos said the market appears confident the Fed won’t lose control of inflation, pointing to the so-called breakeven rate on five-year, five-year forwards, an indicator of future inflation pressure, which he noted was hardly moving.
“Risk assets should stabilize here and resume their uptrend as good news on the economic growth front will dominate the headwinds from a Fed that needs to stay a little higher for a little longer to fully anchor long-run inflation expectations,” Zervos said. He praised Fed Chair Jerome Powell for pushing back against cutting interest rates last year.
“He looks more than vindicated today in his hawkish wait-and-see stance,” Zervos said, adding that former Fed Chair Paul Volcker “would be proud.”