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As Fed Sets Stage for March Rate Hike, Stock-Market Investors Face 'Perilous' Backdrop of Higher Volatility

Dow Jones2022-02-02

Investors, particularly those reliant on computer-generated decisions to buy or sell, face a treacherous backdrop of volatility driven by the Federal Reserve, following a brutal month of stock trading.

January’s violent moves in equities offer a glimpse of what might still be in store: The S&P 500 SPX, +0.69% and Nasdaq Composite COMP, +0.75% indexes finished the month with their biggest percentage declines since March 2020, while the Dow Jones Industrial Average DJIA, +0.78% staged an unprecedented 1,214-point reversal in a single day last week. Meanwhile, two- and five-year Treasurys, with rates reflecting the short- to intermediate-term path of Fed policy, are off to their worst start to a new year in more than three decades, according to Dow Jones Market Data.

At issue is uncertainty over just how far the central bank is willing to go to tackle the highest U.S. inflation in almost 40 years, starting with a widely anticipated rate hike in March, investors and strategists say. That uncertainty is, ironically, giving way to at least one area of greater clarity: Big market swings are probably here to stay.

“Volatility is probably the only thing that my compliance department would allow me to guarantee,” said John Lynch, the Charlotte, North Carolina-based chief investment officer for Comerica Wealth Management, which oversees $175 billion in assets. “It could be 15 to 18 months until we get full clarity on the extent of Fed tightening, and the market is susceptible to further bouts until then.”

Meanwhile, “investors need to be prepared for more equity-market volatility, and those caught up in quant or algorithmic trading may get hurt,” he said via phone Tuesday.

Complicating the Fed’s task ahead is a pair of competing forces: One is the likelihood of no near-term letup in inflation, given signs of building price pressures from factors unrelated to U.S. labor and supply shortages. They include strong demand for merchandise and drought conditions outside the U.S. that are driving up the price of commodities like soybeans.

The other force is worries about a potential economic slowdown — as flagged by the International Monetary Fund in January, and the Treasury market, which has flashed repeated warnings about the growth outlook since October. While many say higher inflation makes the case in favor of more aggressive Fed rate hikes, the prospect of a downturn supports the view that inflation could subside and policy makers need to be more cautious about tightening — which, together, are generating even more volatility for financial markets.

The Fed will be “hard-pressed” to lift the fed-funds rate target to its long-run objective of 2.5%, from a current level between 0% and 0.25%, and is more likely to get no higher than 1.5% to 2%, according to Comerica’s Lynch. Despite growing expectations that the Fed could deliver a half-point hike in March, a nonfarm payrolls report that comes below expectations for February might be enough to remove that option, he said.

Add to this environment a continuing debate about the degree to which shrinking the Fed’s nearly $9 trillion balance sheet will tighten financial conditions, or could act as a substitute for rate hikes–a process that some have dubbed as “dual tightening.”

In a BofA Global Research note Monday, strategists Andy Pham and Francisco Blanch, along with analyst Chintan Kotecha, wrote that “with risks tilted asymmetrically higher and all but confirmed by the Fed following the January meeting, we think quant investors should brace for a higher vol environment.”

They said they see the backdrop as “perilous,” but say that “pockets of alpha can still be found across commodity and FX risk premia.”

Quantitative systems have been used in recent years as a way to beat the market and post solid returns, while high-frequency trading algorithms have helped to make trading cheaper for many and account for a large portion of the buying and selling of U.S. shares that take place.

U.S. stock benchmarks shook off a tentative start by late Tuesday, with the Dow industrials, the S&P 500 and Nasdaq Composite all posting gains. Meanwhile, Treasury yields were also higher, with the 10- TMUBMUSD10Y, 1.792% and 30-year rates TMUBMUSD30Y, 2.114% having their biggest advances in almost a week.

“We’re going to see increased volatility among asset classes, and it’s very possible that quant investors would get hit hardest,” said Calvin Norris, portfolio manager and U.S. rates strategist at Aegon Asset Management in Cedar Rapids, Iowa, which oversees $463.8 billion. “I do agree that it will be a long time before we alleviate a lot of the factors causing inflation, and there’s some reason to believe we’re going to see a tailwind from inflation for some time.”

“The pace of Fed rate hikes and the pace of balance sheet runoff, we don’t know. So at this point, the market is left to its own imagination and can spin a hawkish or dovish story for itself,” he said via phone.

Disclaimer: Investing carries risk. This is not financial advice. The above content should not be regarded as an offer, recommendation, or solicitation on acquiring or disposing of any financial products, any associated discussions, comments, or posts by author or other users should not be considered as such either. It is solely for general information purpose only, which does not consider your own investment objectives, financial situations or needs. TTM assumes no responsibility or warranty for the accuracy and completeness of the information, investors should do their own research and may seek professional advice before investing.

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Comment23

  • rlgt
    ·2022-02-03
    K
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  • robot1234
    ·2022-02-03
    In general, US stock valuations are at record high after last 2 years of relentless rise. Better to exercise caution and err on the safe side under current market condition of rising inflation, interest rate hikes and Fed tapering of her massive $9 trillion dollars balance sheet. Besides, the ongoing trade war and Covid-19 pandemic. As Warren Buffett once said in a letter to his shareholders, “It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
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  • 喜慶吉祥好運
    ·2022-02-02
    🧐🤔🙂
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  • LimLS
    ·2022-02-02
    Yes. Many unknowns now and Powell speech did not give a clear guidance. With no FOMC in Feb, we can only wait for more hints during end Mar. Until then, more volatility is expected. The market don't look too optimistic with more people forecasting 5 hikes this year. If one want to buy the dip, only buy the strong companies and buy slowly. Don't go all in.
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  • MelChen
    ·2022-02-02
    Good
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  • HENRYCSC
    ·2022-02-02
    Thanks
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  • AS78
    ·2022-02-02
    Ok
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  • leemoney
    ·2022-02-02
    Nice
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  • Greg2021
    ·2022-02-02
    Volatility is good for traders 
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  • Greg2021
    ·2022-02-02
    Volatility is good for traders
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  • VivianChua
    ·2022-02-02
    Hope is bullish 💚💚💚
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  • Zack44
    ·2022-02-02
    More to come and more to watch…
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  • time to eat
    ·2022-02-02
    Just buy
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  • eddiechew
    ·2022-02-02
    Fundamental trading is the most impt
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  • JuniorShiba
    ·2022-02-02
    Ok
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  • robot1234
    ·2022-02-02
    Now is not the time to be aggressive in the US Stock or Crypto Markets. Better to be patience and err on the safe side after last year numerous ATH. Can consider paying some attention on the Asia markets esp China. US can win the technology war against China but will continue to lose market share.
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  • AE2
    ·2022-02-02
    Expected
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  • ARIESan
    ·2022-02-02
    Ohhhhhh 
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  • PearlynCSY
    ·2022-02-02
    Expect more volatility with a downside bias as US Stock Markets suffer from a triple whammy of highest inflation in 40-year, interest rate hikes and FED reducing her massive $9 trillion balance sheet. US National Debt is now at an extremely alarming level of $31..4 trillion dollars. Besides, many other negative factors esp Sino-US relationship, Ukraine crisis and the continuation of the Covid-19 pandemic.
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  • ThunderPat
    ·2022-02-02
    Why can't the market return to just trading based on the fundamental?
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