Analysis: Hopes of elusive Fed pivot drive markets higher once again

NEW YORK, Oct 4 (Reuters) – Investors, suffering from a bloody year for markets, are hoping recent signs of faltering economic growth will force the Federal Reserve and other global central banks to step down in the fight against inflation Hitting the gas, sparking strong rallies in stocks and bonds.

The S&P 500 is up nearly 6% over the past two days after a brutal September that saw it fall 9.3% amid declines in other global equity benchmarks. US Treasury yields, which move inversely with prices, fell 33 basis points in October from multi-year highs hit last month.

Investors’ expectations of how much the Fed will hike rates to fight inflation have fallen in recent days amid signs that US growth may finally be slowing. Investors in the futures markets now expect the Fed fund rate to peak at 4.5% next year, compared to the expected peak of around 4.7% they priced in last week.

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“Markets are sniffing the blink of an eye at the Fed,” said Jim Paulsen, Leuthold Group’s chief investment strategist. “If they pause here, not only will interest rate pressures suddenly fall, but there may be a mid-cycle slowdown, rather than a recession.”

Markets have rallied several times this year on hopes of a Fed pivot, only to reverse and crumble to new lows, making investors wary of the current rally. This time around, a string of weaker-than-expected US manufacturing and jobs data are among the factors fueling hopes that weaker growth will prompt the Fed to slow market-punishing rate hikes.

Some investors have also taken Tuesday’s less-than-expected interest rate hike by Australia’s central bank and a decision by the new UK government to scrap planned tax cuts as signs that governments and monetary authorities are increasingly reacting to signs of slowing growth and market instability.

“There is a growing sense that financial markets are sufficiently stressed to warrant a collective turn away from the global trend towards tighter monetary policy,” said Ian Lyngen, head of US rates strategy at BMO Capital Markets.

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Many market participants are skeptical that the recovery in equities and bonds will continue. Mark Haefele, chief investment officer at UBS Global Wealth Management, attributed the equities rally to “oversold” conditions in the S&P 500, exacerbated by month-end rebalancing by wealth managers in late September, which drove equities lower.

Sentiment was echoed by Jack Janasiewicz, portfolio manager at Natixis Investment Managers Solutions, who believes the recovery was supported by bearish investors who covered their positions after September’s deep declines.

“Towards the end of last month the mood got pretty bearish and it doesn’t take much to scare some of these guys to come in and cover their positions,” he said.

Analysts at BofA Global Research on Tuesday pointed out that retailers have shown few signs of capitulation, a signal they say represents a potential market bottom. Meanwhile, the Cboe Volatility Index (.VIX), known as Wall Street’s fear gauge, has failed to climb to levels that would have marked earlier turning points in previous sell-offs.

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“I don’t realize you’ve seen panic yet,” said Ashwin Alankar, head of global asset allocation at Janus Henderson Investors. “Until you see panic, it’s not the best time to quickly add risk to a portfolio.”

Meanwhile, signs of a slowdown in the labor market highlighted by the JOLTS data may not be enough for the Fed to halt the pace of rate hikes, analysts at Capital Economics wrote on Tuesday.

While the data “won’t prevent more aggressive rate hikes in the near term…it supports our view that inflation will fall faster than Fed officials expect,” they wrote.

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reporting by David Randall; Additional reporting by Davide Barbuscia; Edited by Ira Iosebashvili and Josie Kao

Our standards: The Thomson Reuters Trust Principles.

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