Risk perception in market pricing

Market approach… After the Fed’s 75 basis points increase and the statements that the fight against inflation is a priority, the S&P 500 index continues to stay in the negative zone. The thought that Powell and Fed members may increase interest rates by 75 basis points in the upcoming meetings causes the dollar index and US bond yields to rise.

Stocks and bond yields… Global stock markets continue to follow the selling route with the widespread belief that monetary tightening can harm growth and cause recession and even stagflation. New economic data and aggressive Fed expectations sharply boosted Treasury yields. The yield on 10-year Treasury bonds is the highest since 2011, while the 2-year yield is the highest since 2007. Despite this, short-term real interest rates are still in negative territory, despite nominal returns increasing through 2022.

The FOMC raised the target range for the federal funds rate by 75 basis points, the largest rate hike in 27 years. The committee also pointed out that an aggressive pace of tightening is ahead. The Fed’s dot chart showed that policymakers expect additional tightening of a median 175 basis points by the end of this year.

Comparison of S&P 500 index and US 2-year and 10-year bond yields.. Source: Bloomberg

Conclusion? In response to alarms about inflation, the FOMC went even more hawkish. With the Fed’s balance sheet shrinking, financial conditions will tighten significantly in the coming months. Softening demand in a high-cost environment will likely tighten profit margins for companies as well. Falling profits will also cause cuts in capital expenditure and production.

We think that the PMI and non-farm employment data will provide important information about the course of the US and global economies in the upcoming period. The effect of slowing growth turning into contraction has increased the risks of a recession in 2023. Concern about the negative contribution of the Central Bank’s aggressive tightening to economic slowdown factors such as supply chain and geopolitical risks was effective in the increase of these risks. Flattening or reversing of the Treasury yield curve will be followed as an important indicator in this regard.

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