After the horrible CPI report Friday, it appears the worst-case scenario for the economy is happening, with higher inflation and earnings warnings coming from tech and consumer discretionary stocks. Equities quickly faded Wednesday’s post-FOMC rally as traders have gone from expecting a soft landing to fearing an imminent recession.
With aggressive rates hikes, inflation is expected to slow as consumer demand is pulled down, but the cost of credit and capital investment is rising which will squeeze corporate earnings. In reaction, a combination of lower earnings estimates as well as additional private sector layoffs will ensue.
Chairman Powell said that the committee objective is to bring inflation down to 2 percent while the labor market remains strong. This implies that in order to combat inflation, the economic offset is to decelerate growth in the labor market which will add less pressure on consumer purchasing power.
Powell and the committee demonstrated that they are perfectly willing to change their hawkish stance in the face of new data, but markets have become unhinged considering the speed and magnitude of the latest move in treasury yields in the last week. If we simply consider Bitcoin as a proxy of risk appetite, investors have become worried about a much quicker deterioration for the U.S. economy.
Second quarter earnings and guidance throughout July and August will let us know the extent of the damage and determine whether equities can reach a bottom. If you think the Fed is going to push us into a recession, you should also think that the stock market is expensive and has more room to fall.
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