(Bloomberg) — Investors just took a step back in the Fed’s tightening campaign and ignored the Fed concerns that governed them for 15 months.
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The S&P 500 capped a fifth consecutive week of gains and is now higher than it was on March 16, 2022, the day the Federal Reserve embarked on its most aggressive rate hike in four decades. US equities are not alone – from the dollar to bond volatility to the stock market situation, major metrics are back near levels seen 500 basis points ago for a price increase.
Once tied to the Fed’s efforts to ease economic growth and inflation, markets are now focused on the health of corporate balance sheets and the potential for an increase in capital expenditures as companies retool for the AI boom.
Macroeconomic contribution to equity markets fell to 71% from 83% since March — the largest three-month decline since 2009, modeled by Citigroup Inc.
“The Fed is likely to be less important over the next six to 12 months than it has been,” said Jonathan MacKay, head of platform distribution at Schroders. “Global drivers and other fundamental drivers will take on a larger role as the Fed is likely to begin its hiatus.”
With the Federal Reserve signaling the near end of interest rate hikes, Treasury investors are expecting volatility to subside after enduring some of the biggest daily yield swings in years. China’s geopolitics and economic power are expected to regain their prominence in investment theses.
“We knew earlier that the Fed was going to raise interest rates because it also did because inflation is so high,” said Fiona Cincotta, senior market analyst at City Index. “Now, it will be more data-driven.”
Markets experienced the first half of 2023 coaxing investors away from the sidelines and forcing strategic reversals by some of the biggest bears on Wall Street. A measure of total equity position by Deutsche Bank AG has increased weight for the first time in more than 16 months, bringing it back to levels last seen before the start of the cycle.
Volatility eased in bonds and stocks: The ICE BofA MOVE index of expected price volatility in US government debt is trading near a previously hardened rock bottom, while the Cboe’s volatility index which measures stocks is hovering around levels last seen in 2020.
Dollar strength, supported by rates, also faded with the Bloomberg Spot Dollar Index trading near levels seen in April 2022, down nearly 10% since its record high.
The S&P 500 recorded its moderate reaction on FOMC Day two years ago. Although it was the first in 11 meetings where policymakers held interest rates, they also raised expectations for higher borrowing costs by 5.6% in 2023, which would mean a quarter-point or half-point increase in interest rates before the end of the year.
Contrast that with markets that have been hung on every word Fed officials have said in the past year.
A bull market is also teetering on a 65% chance of a US recession within a year, economists estimate. The collapse of four regional banks and upheavals along the US treasury curve brought back the issue of deflation. Wall Street veteran Bob Michell predicts a recession by the end of the year that will force the Fed to switch to easy policy.
For now, the US economy appears to have weathered the onslaught of rate hikes with resilient labor markets and mostly healthy corporate balance sheets. Among the biggest bears in the market, Bank of America strategists raised their target level for US stocks and became more optimistic about the economic outlook, predicting a “subsequent and milder decline.”
But Peter Chatwell, for example, is not convinced that economics or markets can resist the allure of more hawkish politics for long.
“The rally is typical of a bear market rally, not an outright market rally,” warned the head of global macro strategies trader at Mizuho International Plc. The rate hike is “on a weak basis, and is subject to repricing to higher interest rates over the medium term.”
Whether the bull market is real or not, it attracts investors. In the past three weeks, US equity inflows totaled $38 billion, the strongest momentum for inflows into the asset class since October, according to Bank of America, citing EPFR Global.
“It looks like investors have finally thrown in the towel and started chasing the rally,” said Emmanuel Cao, Head of European Equity Strategy at Barclays. “As long as the US recession continues to subside, we think stocks can continue to go higher.”
– With the help of Lu Wang.
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