Sustained bull rally needs clear Fed pivot from rate hikes
- A sustained bull market will likely be elusive until the Fed signals a clear shift from plans for future rate hikes, says UBS Global Wealth Asset Management.
- Economic growth is slowing, but wage growth is still too high for the Federal Reserve’s liking in a scorching inflationary environment.
- The Swiss investment bank sees July’s stock rally as a bearish rally.
The surge in stocks in July was a bearish rally, and a sustained bullish rally is unlikely until the Federal Reserve clears away from plans for further interest rate hikes, says a major asset allocator at UBS.
In a note released on Wednesday, the Swiss bank addressed a debate in financial markets that followed the Fed’s policy meeting last week, with the discussion centering on signals from the central bank on the future of rate hikes. The vast majority of investors argued that the Fed “was dovish and effectively pivoted,” while the other camp believed Chairman Jerome Powell delivered “the same hawkish message” as last month.
“Different opinions are a healthy aspect of financial markets, but the quick conclusion reached by those in the dovish camp is a bit surprising,” said Jason Draho, head of asset allocation for the Americas at UBS Global Wealth. Management, in its note.
The market has become more optimistic about lower inflation, he said. “The labor market,” however, “is still too hot for the Fed to achieve price stability. ‘step up again.’
Investors will get a snapshot of US payrolls from Friday’s nonfarm payrolls report for July. The June report showed that the average hourly wage increased by 5.1% over the past 12 months. Last week, the Department of Labor said its employment cost index for the second quarter rose 1.3%, faster growth than the widely expected 1.2% rate.
The Fed has raised its key rate four times this year, within a range of 2.25% to 2.5%. Consumer price inflation was 9.1% in June. The rapid pace of sharp rate hikes has fueled expectations of slowing inflation as rising borrowing costs dampen demand.
“The slowdown in economic activity was a boon for risk assets last month as investors anticipated a less hawkish Fed,” Draho said. The S&P 500 jumped 9.1% in July, its best monthly performance since November 2020. UBS shared the general view that the July decision was a bearish rally, supported by investor sentiment which remains pessimistic about the macroeconomic outlook, among other factors.
“It remains a challenging economic and market environment, and the fundamentals haven’t changed enough to expect a different future Fed path today compared to a week ago,” Draho said. “Until inflation falls convincingly to acceptable levels and the Fed has undoubtedly pivoted, a new sustained bull market in risk assets is unlikely.”