With inflation not coming down as quickly as hoped and the global economy holding up better than expected, investors are looking for interest rates to remain higher for longer, resulting in a negative impact in equity markets – the S&P 500 being down 3.2% over the last month even after an almost 3% rebound last Thursday and Friday.
- The global economy is running hotter than expected with higher inflation. Euro-zone core inflation was up in February, as was core PCE inflation in the U.S. in January – albeit slightly.
- Although the market expectations for Fed funds rates had risen this past week to a peak rate of 5.4% — slightly above the Fed’s most recent projections — the consensus outlook for February and March U.S. inflation is 4.7% by the end of March, thereby putting the Fed funds rate above the expected rate of inflation.
- In addition to expecting higher rates, investors no longer expect rates cuts in the second half of the year, which in turn prompted the sell-offs in equity and fixed income markets.
- Higher interest rates create downward pressure on valuations and U.S. equity prices, with “rate sensitive” sectors underperforming.
Financial markets will be watching for the February employment report due out Friday and Fed Chair Jerome Powell’s testimony to Congress Tuesday and Wednesday for a better understanding of whether speculation about interest rates going “higher for longer” is justified.
- After the unexpected 517,000 jobs gain in January, the February employment report likely will show an increase of 200,000 non-farm jobs and a slight up-tick in unemployment to 3.5% from 3.4% in January.
- If the January jobs gain and PCE inflation data turn out to be aberrations, then the Fed likely will continue with two – or maybe three – more ¼% rate increases in March, May and June.
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