The ongoing Fed rate hike cycle is one of the key sources of volatility in global markets. Since August 2021, when investors began recalculating fundamentals, the US dollar index (DXY) has risen by 14% to a 2002 high, 10-year US Treasury yields have risen from 1.2% to 3%, the number of rate hikes expected in 2022 – from one to seven.
The American stock market came under strong pressure in April, the NASDAQ lost more than 16% ($3.5 trillion capitalization) over the month, the benchmark fell by 21% ($5.7 trillion) since the beginning of the year, while almost half, $2.5 trillion losses index, due to the sale of FAANG shares. Growth stocks make up at least 60% of the US stock market, their current multiples are not justified and are in danger of being reassessed.
S&P has fallen by 13% since the beginning of the year, while in April – by 10%, the fall for the reporting month was the highest since 2008. To a large extent, the decline was due to a reassessment of the Fed’s rate hike path and volatility in the global market due to geopolitical factors and increased recession risks, which the market discounts until the end of the first half of 2023. The special operation in Ukraine added 1.5% to the US consumer inflation index and 2.5% to the EU.
Despite a significant tightening in financial conditions in equity and bond markets, which outflowed more than $30 billion in April alone, we think investors are not taking into account a more hawkish stance by the Fed that will push rates outside the neutral range this year. 2.25-2.5%. We believe that under the worst-case scenario, the NASDAQ could fall another 20% in the second quarter, to 10,000p, and the S&P 500 another 14%, to 3,500p.
What will upset the markets?
- Raising the rate by 75 bp in May or June, as first mentioned by the head of the St. Louis Fed, James Bullard.
- The trillion-dollar question is the Fed’s rhetoric on the median neutral rate. Will the Fed aim for a 2.2-2.5% range, or just point the way? In the first case, after raising the rate by 50 b.p. another 50 bp increase is possible in May. in June and July, and in the second – the rate will increase by more moderate amounts.
- Hawkish comments from the Fed on good macroeconomic data for March (PMI, employment, etc.), despite the unexpected contraction of US GDP in the first quarter.
- Hawkish comments from Fed officials on the special operation in Ukraine and its implications for inflation and energy prices, as well as for economic activity.
- Our Fed rate hike forecast: May (50bp), June (50bp), July (50bp), September (25bp), November (25bp) , December (25 bp) = 2.75% compared to analysts’ median expectations of 2.25%.
What is included in the prices?
- The value of the Overnight Index Swap reflects the Fed’s rate hike to 2.2% by the end of the year (median Fed expectations for the end of the year is 1.9%) and to 2.8% by the end of 2023.
- After raising the rate by 50 b.p. in May, investors expect a moderate rate hike, by 25 bp, based on the results of each of the next five meetings
- Announcement of the beginning of the reduction of funds on the Fed’s balance sheet in June through a passive outflow of $95 billion
- The Fed’s Open Market Committee will increase the rate hike range by 50 bp. up to 0.75-1%