(TheStreet) - Hawkish comments from Fed Chairman Jerome Powell during his semi-annual trip before the Senate Banking Committee triggered a broad selloff in equities on Tuesday.
Powell noted that inflation is running higher than the Fed had expected during the last Federal Open Market Committee get-together. All the major averages were down more than 1%, with the S&P 500 falling slightly more than 1.5%.
Futures are now pricing in a more than 70% chance that the Fed will hike rates another 50 basis points in two weeks at the central bank's next meeting. That is more than double the odds from just a few days ago. BlackRock's chief investment officer of global fixed income believes Powell & Co. could move the fed funds rate up to the 6% level and keep them there for an extended amount of time in order to crush inflation.
My longtime readers know I have had a cautionary stance on equities for more than a year now. I was one of many who realized early on that inflation was neither "temporary" nor "transitory" and that the oracles at the Federal Reserve were behind the curve in moving to put the inflation genie back in her bottle.
Investors are paying the price for that policy error as the central bank is in the midst of its most aggressive monetary tightening since the days of Paul Volcker. Despite the market being down substantially from where it started when the Fed commenced its current round of interest rate hikes, I believe more downside is ahead for the overall market.
I also believe investors continue to underestimate the impacts of this policy shift on equities and the economy. A key economic driver, the housing sector, is taking it on the chin right now. Things are likely to get significantly worse in this area of the economy before they get better. Not surprisingly given the recent uptick in mortgage rates, February housing sentiment in the U.S. moved closer to its record low after three straight monthly increases.
Ordinarily, one would expect banks to benefit from higher interest rates thanks to improvements to their net interest margins, a key driver of earnings in this sector. However, any benefit here is offset by rising delinquency rates and increasing write-offs. Loan demand also is ebbing and a deeply inverted yield curve is not helping matters, either, so it is no surprise that banks were one of the poorest-performing sectors in the market in trading Tuesday. Many regional banks are back near their 2022 lows now.
Finally, after a decade and a half of very low or near-zero interest rates, equities are no longer in a TINA (there is no alternative) environment. That is something I think too many investors are discounting. Why put money at risk in stocks in a very uncertain economic environment when you can park cash in short-term Treasury bills yielding 5%? How much more appealing will this move become if this risk-free rate moves to 6% as Blackrock is projecting?
That to me is a key, $64,000 question around any coherent outlook for the market.
By Bret Jensen
March 8, 2023
