Why the pursuit of a “soft landing” of the economy does not guarantee a fall on Wall Street

Even if the Federal Reserve can do the difficult task of quelling high inflation without pushing the economy into a trench, that does not necessarily mean that markets will be out of trouble.

Stocks and bonds have already had a rough start to the year, before the Federal Reserve begins its monetary tightening cycle in earnest. Next week, the central bank is expected to pull the trigger for the first time Increasing the rate by half a percentage point in more than two decadesAnd start shrinking its balance sheet, which is close to $9 trillion.

The Fed’s Efforts Are Aimed To Facilitate The Climb The cost of living, now at its highest since then In the early 1980s, before the recession took hold, but higher interest rates and tighter financial conditions could also mean more pain on Wall Street.

“There seems to be a lot of discussion going on about whether the Fed can achieve a ‘soft landing’ for the economy,” David Del Vecchio, co-chair of investment-grade US firms at PGIM Fixed Income, said by phone. “That seems to be a real challenge in this environment where they are really behind the curve.”

With Goldman Sachs mode Odds of a recession at 35% “The potential for heavy selling in the markets is even higher,” Del Vecchio said over the next 24 months.

stock market massacre

Stocks ended April bruising Even more lower on Friday, with both the Dow Jones Industrial Average and the Dow Jones Industrial Average,
and the S&P 500 SPX Index,
It recorded its largest monthly decline since March 2020.

Ongoing carnage in high-tech stocks helped slide the S&P 500 down Return to the correction area For the second time in 2022, while delivering the Nasdaq Composite Index,
It fell 13.3% in April, its biggest monthly drop since October 2008.

Rode the “Standard & Poor’s 500” height, such as A handful of major tech companies Helped American companies set records win last year, Don Townswick, director of equity strategies at Conning, said over the phone.

“Unfortunately, it’s going to bring these stocks down a bit,” he said. “The market has become very dependent on these companies for its direction.”

What’s more, a hawkish Fed will continue to pressure developing stocks, Steve Schiavaroni, senior portfolio manager and equity strategist at Federated Hermes, said in a client note Thursday.

While there may soon be “tactical opportunities” in technology and related growth stocks given the recent violent selloff, Schiavaroni cautioned that “valuations continue to shrink,” mainly due to higher rates.

Bond defeat

Bonds have often succumbed as flat, boring, and lower-risk investments, with highly rated US corporate bonds in Worst performance since the collapse of Lehman Brothers in 2008.

“Total returns have been more negative than we’ve been used to for a very long time,” Del Vecchio said.

Goldman analysts pegged overall returns for the year at negative -12% for investment-grade US corporate bonds, and debt issued by several Fortune 500 companies.

Sector spreads, or premium bonds that pay out risk-free Treasury yields to help offset default risk, widened by about 50 basis points (see chart) from last year’s lows as well.

Investment grade corporate bonds jump from all-time lows

Federal Reserve data FRED. Index of American companies ICE BofA

“The background was so good that the spreads were able to narrow to very rich levels,” Del Vecchio said. Recent levels seem closer to “fair value,” he said, but he believes they can still cheap due to uncertainty over the course of rate hikes, geopolitics and the Fed’s balance sheet cut plans.

“I think you want to be selective here,” he said. “Because the potential runway for stagnation is so long, that means you’re likely to have a few rallies now and then. And maybe you should think carefully, and use those rallies, if they come, to mitigate the risks.”