What's roiling stocks as the Fed moves toward rate hikes

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Tuesday, January 25, 2021

Fears of a policy error are overriding Q4 earnings

Remember those “landmines” the Morning Brief recently warned could detonate in 2022? One of them is just days from going off, and at the worst possible time.

The head-spinning volatility that’s been throttling investors since the new year culminated on Monday by briefly dragging the S&P 500 index into correction territory. The whipsaw price action, consistent with a "fire and ice narrative" coined by the sages at Morgan Stanley, ended with Wall Street clawing back those losses to close in the green. Time to breathe a sigh of relief, then?

Not quite. A less than impressive earnings season — which has started “with a whimper at best” as Yahoo Finance’s Brian Sozzi so eloquently phrased it on Monday — is about to take a back seat to the Federal Reserve’s policy meeting on Wednesday. The central bank is widely expected to begin laying the foundation for a series of interest rate hikes that it hopes will tame spiking prices created by excess liquidity and strong demand.

“For much of the past decade, market volatility was calmed by the notion that the Federal Reserve and other global central banks stood ready to step in to support the economy in the event of weakness, exogenous shocks, or an unexpected tightening in global financial conditions,” wrote Mark Haefele, CIO of Global Wealth Management at UBS.

“Today, with inflation still elevated, that support feels less certain, and this week’s Fed meeting is likely to underscore the Fed’s shift in policy priorities away from supporting growth and toward fighting inflation,” he added.

And therein lies the rub. The subtext of the rout in technology shares is reflective of market fears that a policy error will bring rates up too high, too quickly.

“I would be very [reluctant] to look at getting in or adding to positions to anything until we hear from an increasingly hawkish Fed on Wednesday,” Strategic Funds Managing Director Marc LoPresti told Yahoo Finance on Monday.

Rate hikes — which translate into higher borrowing costs for consumers and businesses — are particularly anathema to high flying tech stocks like Tesla (TSLA) and Amazon (AMZN), which on Monday were pummeled to a fresh 52-week lows. It’s what LoPresti referred to as a “plethora of pain” that’s mounting for investors.

Tech stocks, which hit correction territory last week, have become a leading indicator of investor concerns that the Fed may overcorrect on its ultra-accommodative monetary policy — and perhaps not a moment too soon. As inflation eats away at consumer purchasing power, the imperatives of COVID-19 easy money are giving way to the need to fight price pressures.

"I'm extremely worried about much higher interest rates, not because the Fed will move it there, but people will realize that they have to borrow money and leverage in order to keep up with inflation. And so I think that the Fed will lose control," Interactive Brokers (IBKR) Chairman Thomas Peterffy told Yahoo Finance last week.

Some investors, like Northern Trust Wealth Management CIO Katie Nixon, think Omicron may restrain the Fed’s most hawkish impulses.

Yet she acknowledges that the consequences of an aggressive policy shift “would lead to turmoil in the financial markets and then feed through the real economy, increasing the risk of a recession. The Federal Reserve is acutely aware of this risk and will be extremely cautious with applying policy that could cut the recovery short and undermine the goal of full and inclusive employment,” Nixon added.

Given that benchmark rates will still run below the rate of inflation, currently at 7%, Veteran market strategist Louis Navellier thinks the market’s fear of higher rates is “ridiculous.”

Yet the analyst noted that, in order to “break the back of inflation, the Fed has to engineer a "soft landing," which is easier said than done,” Moreover, hiking rates will simultaneously increase the interest rate burden on the federal debt, which currently sits near $30 trillion, Navellier added.

That latter suggestion, an idea the Morning Brief broached recently, is at the heart of a warning issued by the U.K.-based Jubilee Debt Campaign. Higher interest rates may spark a global debt crisis, especially for developing markets, CNBC reported on Monday.

To summarize, the Fed is walking a tightrope that’s straddling inflation, bloated government balance sheets, and a pandemic-hit economy. And the outcome will determine whether a market coddled by central bank liquidity can continue to rally.

By Javier E. David, editor at Yahoo Finance. Follow him at @Teflongeek

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