Source: Zhitong Finance

Fears about a rebound in inflation are forcing investors to prepare for what few people expect in 2024: the US will not cut interest rates this year.

Expectations about how much easing the Federal Reserve can implement are rapidly declining, as strong economic reports one after another show that if the Fed cuts borrowing costs too soon, inflation may make a comeback.

These concerns became even more pressing after strong consumer price data was released on Wednesday: the futures market now shows that investors expect interest rates to fall by only 40 basis points this year, compared to 150 basis points in early 2024.

The weakening prospects for interest rate cuts have left market participants who have bought stocks and bonds in a big way in the past few months hoping for policy relaxation. Some of them have had to make hasty adjustments to their portfolios.

Although the S&P 500 is close to record highs, some stock market investors are buying insurance in the options market or investing in popular inflation-hedging tools such as energy stocks, fearing that a key bullish support may be fading. The index fell nearly 1% on Wednesday.

Bond investors are already feeling the pain, and they are reallocating their portfolios as weeks of sell-offs weigh on the price of US Treasury bonds. The 10-year US Treasury yield hit its highest level since November last year, breaking 4.5% on Wednesday.

Tara Hariharan, managing director of the global macro hedge fund NWI, said: “The US may not cut interest rates in 2024, or at least less than current market prices.”

In December of last year, Federal Reserve Chairman Powell confirmed the expectation that the Federal Reserve would switch to cutting interest rates. Policymakers expect to cut interest rates by 75 basis points in 2024, but this outlook depends on inflation continuing to cool down.

Since then, the market value of the S&P 500 has increased by about 4.7 trillion US dollars and climbed to a record high, as investors bet on a so-called soft landing scenario where the Federal Reserve can curb inflation without harming economic growth.

However, strong data over the past few months has led some investors to question whether the excitement surrounding the economic shift is too early. These concerns are evident in the bond market, where bond yields have been rising steadily in recent weeks.

Tim Murray, capital market strategist at T. Rowe Price, said he has been moving out of fixed income products and is concerned that a rebound in inflation may erode future cash flow from bonds.

“Bonds are a good hedge against recession, but not a good hedge against inflation,” he said.

He has also been increasing his positions in energy stocks, which are a popular hedge against inflation as oil prices soar. Energy stocks in the S&P 500 index rose 17% this year, dwarfing the 8.2% increase in the S&P 500 index.

Rick Rieder, chief investment officer of the global fixed income division of BlackRock, the world's largest asset management company, said that in the past few months, he has reduced the interest rate exposure of some of his managed portfolios by selling certain short- and long-term bonds, including the $2.7 billion BlackRock Flexible Income ETF. If interest rates rise, these bonds could be hit harder.

In contrast, US bond giant Pacific Investment Management (PIMCO) has been increasing its interest rate exposure or term, believing that after the recent sell-off, bond pricing has become more reasonable. After the Federal Reserve released strong data on the US job market last week, the market lowered expectations for interest rate cuts.

Mike Cudzil, the fund's portfolio manager, said: “If there's any difference, we're considering when we should increase our holdings.”

NWI's HariHaran said that the yield on longer-term US bonds was “too low due to the excessive supply of bonds.”

At the same time, signs of caution in the stock market are increasing. Bank of America customers sold a net $3.4 billion share sale last week, with individual stocks showing the biggest outflow of capital since July 2023, the company said in a report.

Scott Wren, senior global market strategist at Wells Fargo Investment Research Institute, said his company has positioned short-term fixed income assets as a “stopping point” to wait for the stock market to recover and invest capital in the stock market.

“The Federal Reserve's next move is to cut interest rates, but you'll have to wait,” he said.

Stock investors are also seeking protection in the derivatives market. The Chicago Board Options Exchange Volatility Index is hovering near a two-month high. The index is based on options and measures investors' need for portfolio protection.

Bryant vancronkite, senior portfolio manager at asset management firm Allspring, believes that continued rise in commodity prices may be the main risk facing the stock market, as this may accelerate inflation and offset the impact of interest rate cuts. He believes that the market is at a critical moment where it is difficult to predict the next trend of the stock market.

“Honestly, I don't know if it's going to go up 10% or down 10%,” he said.

Editor/jayden