Federal Reserve Chairman Jerome Powell fired a warning shot across Wall Street last week, telling investors the time has come for financial markets to stand on their own feet, while he works to tame inflation.
The policy update last Wednesday laid the ground work for the first benchmark interest rate hike since 2018, probably in mid-March, and the eventual end of the central bank’s easy-money stance two years since the onset of the pandemic.
The problem is that the Fed strategy also gave investors about six weeks to brood over how sharply interest rates could climb in 2022, and how dramatically its balance sheet might shrink, as the Fed pulls levers to cool inflation which is at levels last seen in the early 1980s.
Instead of soothing market jitters, the wait-and-see approach has Wall Street’s “fear gauge,” the Cboe Volatility Index
up a record 73% in the first 19 trading days of the year, according to Dow Jones Market Data Average, based on all available data going back to 1990.
“What investors don’t like is uncertainty,” said Jason Draho, head of asset allocation Americas at UBS Global Wealth Management, in a phone interview, pointing to a selloff that’s left few corners of financial markets unscathed in January.
Even with a sharp rally late Friday, the interest rate-sensitive Nasdaq Composite Index
remained in correction territory, defined as a fall of at least 10% from its most recent record close. Worse, the Russell 2000 index of small-capitalization stocks
is in a bear market, down at least 20% from its Nov. 8 peak.
“Valuations across all asset classes were stretched,” said John McClain, portfolio manager for high yield and corporate credit strategies at Brandywine Global Investment Management. “That’s why there has been nowhere to hide.”
McClain pointed to negative performance nipping away at U.S. investment-grade corporate bonds
counterparts and fixed-income
generally to begin the year, but also the deeper rout in growth and value stocks, and losses in international
“Every one is in the red.”
Powell said Wednesday the central bank “is of a mind” to raise interest rates in March. Decisions on how to significantly reduce its near $9 trillion balance sheet will come later, and hinge on economic data.
“We believe that by April, we are going to start to see a rollover on inflation,” McClain said by phone, pointing to base effects, or price distortions common during the pandemic that make yearly comparison tricky. “That will provide ground cover for the Fed to take a data-dependent approach.”