Just a few months ago, Federal Reserve Chairman Jerome Powell seemed quite prescient. After years of criticism from economists, Wall Street titans and executives for mislabeling inflation as “transitional” in 2021, Powell’s response to the inflation predicament—rapidly raising interest rates—suppressed most of the rise in consumer prices by year’s end. last year without causing a recession.
Annual inflation fell from a peak of 9.1% in June 2022 to just 3.1% by November 2023. But then Powell made a “big mistake,” according to Michael Landsberg, chief investment officer of Landsberg Bennett Private Wealth Management.
As inflation subsided, Powell began hinting late last year that a rate cut was on the horizon. The Federal Reserve’s December summary of economic forecasts showed Fed officials forecast three interest rate cuts in 2024. And even after two hot inflation reports starting this year, Chairman Powell said the new data “really hasn’t changed the overall picture, which is that inflation is gradually moving down the sometimes rocky road to 2%.”
Then, in early April, ahead of the release of March consumer price index data that showed inflation had risen to 3.5%, Powell stood his ground, telling a group of reporters that interest rate cuts were likely “at some point.” this year.
According to Landsberg, this was a completely incorrect remark.
“If he had simply said they would cut rates ‘at some point in the future when the data dictated such a move,’ he wouldn’t have painted himself into a corner, and market participants wouldn’t be hanging on the Fed’s every word, and we’ll be focused on profits,” Landsberg said. Luck by email.
Now a series of reports on high inflation, retail sales and the labor market, as well as looming conflict in the Middle East that raises the specter of an oil price hike, have caused Powell and his Fed colleagues to quickly change their tune. In a message that some experts called “unfriendly” to investors, Powell this week lamented the lack of progress in curbing inflation this year. “Right now, given the strength of the labor market and progress against inflation, it is appropriate to give contractionary policies more time to work,” he said at the Canada-U.S. Economic Relations Policy Forum in Washington, D.C.
According to Landsberg, it is this sharp turn in policy that has led to markets falling in recent weeks. The veteran asset manager even said that given the “re-acceleration” of inflation, he doesn’t expect the Fed to cut rates at all this year.
“While unlikely, there is actually a strong case for the Fed to raise interest rates in 2024, given elevated inflation, low unemployment, high stock prices, the rise of Bitcoin and the resumption of IPOs,” he said. adding, “The Federal Reserve finds itself in a very difficult situation once again.”
What does Powell’s predicament mean for markets?
After rising 27% between October 27 and March 28, the S&P 500 has struggled in the past few weeks, falling about 5%. Landsberg said rising inflation and the prospect of smaller or even no rate cuts are investors’ “biggest concern” and the reason stocks have fallen in recent weeks. The CIO argues that many market participants are looking to make a profit by selling stocks after accumulating profits during the S&P 500’s mega rally before the latest correction. This means there could be more pain ahead.
Landsberg believes investors need to prepare for a “higher, longer” regime and position their portfolios accordingly – with assets that will benefit from higher inflation and interest rates, including stocks in the energy, materials and insurance sectors, as well as commodities such as like oil. “Most investors are underestimating inflation because they believed the Fed when it declared victory over inflation late last year,” he said.
David Donabedian, chief investment officer of CIBC Private Wealth US, a firm with $101 billion in assets under management, echoed Landsberg’s theory about the cause of the recent stock slide.
“The pullback is driven by inflation, the Fed and bond yields,” he said. Luck by email. “Bond yields have risen significantly, largely because there is much less support expected from the Fed than expected a couple of months ago. Investors were looking forward to lower rates and greater liquidity.”
Inflation will likely remain a concern and the Fed is unlikely to cut interest rates as many times as previously forecast, which could continue to weigh on stocks, but Donabedian noted that corrections are normal during bull markets. He said there was a “silver lining” to the recent, hotter-than-expected economic data: “The economy is moving forward.” Economists have significantly raised their forecasts for GDP growth this year, from 1.5% in January to 2.4% in April, according to Bloomberg. data.
First-quarter earnings were also “pretty good,” with about 75% of the company beating consensus estimates, Donabedian said. “And income growth is projected to not only accelerate, but also expand across sectors, with a greater share in prosperity,” he added.
However, there is an elephant in the room: the conflict in the Middle East. What was once a geographically isolated war in the Gaza Strip has now escalated into a regional conflict pitting Iran and Israel and the Houthis attacking ships in the Red Sea. Rising tensions in the Middle East have already driven up oil prices and strained supply chains, but experts fear the global economy and markets could face even greater challenges.
“Right now, the conflict in the Middle East is not driving the stock market, which is focused on inflation, the Fed and bond yields,” Donabedian said. “However, the stock market will follow oil prices… If they rise, the market will take notice. If the conflict goes in the wrong direction, a strong selling reflex is likely to occur.”