Brace for volatility and one thing that could spur the Fed to pivot on rates, a top JPMorgan strategist says
- Stocks could see volatility as the Federal Reserve sticks to its hawkish line, JPMorgan's David Kelly said.
- Fed Chair Powell's signals on interest rates will put the focus on data releases, he suggested.
More volatility may well lie ahead for stocks, given just one economic shock could tip the US into recession, a top JPMorgan strategist has warned.
The bank's David Kelly said the Federal Reserve seems determined to stick to a tough line on red-hot inflation, going by Chair Jerome Powell's speech at Jackson Hole on Friday.
But the JPMorgan chief global strategist said there is one thing that could prompt the US central bank to pivot to cutting rates.
"When the public becomes more fearful of recession than inflation, the Fed will likely slowly return to the more accommodative policy which it maintained in the decade following the Great Financial Crisis," he said in a Monday note.
"This should provide a positive backdrop for both stocks and bonds."
Powell rattled stock markets Friday when he signaled that the US central bank plans to keep interest rates at higher levels until inflation is fully tamed. The VIX index, which tracks stock volatility, hit a six-week high of 27.67 Monday, but has since fallen a notch to 25.51 at last check Tuesday.
The Fed's hawkish tone will have investors closely watching the August US jobs report due Friday, which is expected to be solid and so could nudge the Fed into a 75 basis point interest rate hike. But a mild monthly inflation release in September could reduce the odds of that, according to Kelly.
"For investors, all of this suggests the potential for volatility in the short run," he said.
Kelly said the simplest course for the Fed would be to increase rates by 75 basis points in September, to underscore its hawkish resolve. It could then raise rates by 25 basis points in December, bringing them to a range of 3.75% to 4.00% by the end of 2022, and then halt the hikes in hopes that might be enough for the US economy to dodge a recession.
But he also highlighted the careful balancing act the Fed faced in trying to avoid an economic slowdown — something policymakers have said is a possibility.
"While it is likely that inflation will continue a gradual decline, it is a very close call on recession," he said, pointing to the economic pressures expected in the next few years.
Kelly said the US economy would be really wobbling on the brink of recession over the next year — and would stay like that until short-term drags on the economy have loosened their grip.
"One more shock and we would be in recession," he said.
Over the next few years, there will be a number of risks the economy will have navigate, according to Kelly.
"This will be an environment of fading fiscal stimulus hurting consumption, higher mortgage rates clobbering housing, slow profit growth inhibiting investment, and a high dollar and overseas weakness hurting exports," he said.
"This will very likely mean slow economic growth and sliding inflation."