With multiple cracks emerging in global financial markets, the Federal Reserve may be forced to end its aggressive rate hikes “when something breaks” and to pivot by the end of the World Series this fall, said Guggenheim Partners Global Chief Investment Officer Scott Minerd.
In an outlook posted on Guggenheim’s website, Minerd pointed to the past two weeks of interventions by the Bank of Japan to support the yen and by the Bank of England to help the U.K. bond market as a few of the troubling signs. Cracks are also showing up in credit markets, where deals are being abandoned; in an increase of mutual-fund outflows; and in a rising dollar that’s acting like a wrecking ball worldwide, he said. Mortgage-backed securities are under pressure, while implied volatility has risen in bond, stock, currency markets — all of which are exposing the fragilities caused by rapid aggressive rate hikes in the U.S. and around the world.
Data released on Friday only reinforced the likelihood that the Federal Reserve will continue to rapidly raise interests rates to contain the hottest inflation stretch of the past four decades. The U.S. added 263,000 jobs in September, the smallest gain in 17 months, though just enough to keep policy makers on track. Meanwhile, traders are bracing for the consumer-price index report next Thursday to show another 8%-plus annual headline inflation rate for last month.
“My biggest concern is that further tightening will test the fragilities of market plumbing,” Minerd wrote on Thursday.
“We will soon witness how the players perform as market stresses increase as central banks around the world simultaneously remove liquidity at a record pace,” he said. “Events of the last week demonstrate that shadow market participants, many of which are already highly levered, are facing their own margin calls resulting in them unwinding positions just at the moment when they should be providing liquidity and bidding for securities.”
Minerd is best known for outlooks that contain a mostly downbeat tone. A month ago, he said that he expected the S&P 500 SPX to drop 20% by mid-October, given a bear market that remains intact. On Thursday, he wrote that “the end of Fed tightening will come when something breaks and the Fed will have no choice but to reliquefy the system, an event which I would expect before year-end, and most likely before the end of the World Series.” Game 7 of the fall classic is scheduled for Nov. 5.
The likelihood is growing of more black-swan events like the tumult in the U.K. bond market, which “had the potential to spiral into a global financial crisis if not for the quick action of the BoE.” A black swan is defined as an unpredictable development with extreme consequences, and Minerd has pointed to the risks of one emerging since at least 2020.
Investors reacted to Friday’s job report by sending all three major U.S. stock indexes lower, with Dow industrials
falling around 400 points in morning trading.
Meanwhile, investors sold off Treasurys, which sent yields higher across the board. The 10-year yield
rose 7 basis points to 3.89%. And traders boosted the likelihood of a 75 basis point rate hike by the Fed in November, to almost 82% on Friday from 75% on Thursday — which would take the fed-funds rate target to between 3.75% and 4%, according to the CME FedWatch Tool. They also raised the likelihood of another 75-basis-point hike in December, to 24% — up from 7.4% on Thursday.
In what would be a paradoxical kernel of good news, Minerd said that, in the short run, “a Fed pivot will be good for bonds and risk assets, which are cheap at today’s prices.”
“No one is going to ring a bell when the Fed is forced to pivot. Investors should focus more on value opportunities which abound and stop licking their wounds and trying to pick the bottom,” he said.