Stocks will remain volatile as investors got ahead of themselves pricing in a soft landing with 100 basis points of Fed tightening still to come, UBS say

• Optimism about a soft landing for the US economy is fading, stoking volatility in stocks, UBS said.
• Sentiment is wavering between hopes the Fed will steer the economy from a severe slowdown and fears that it won't.

Stocks are on the hunt for firm direction in the wake of a waning summer rally, with the Federal Reserve unlikely to pause rate hikes until it sees a major improvement in a key inflation gauge, according to UBS.

Equity investors "may have gotten ahead of themselves by pricing in a soft landing," for the US economy, Mark Haefele, chief investment officer at UBS Global Wealth Management, said in a note Tuesday. US stocks fell Tuesday, a day after the equity market logged its worst session in two months, leaving the S&P 500 down by 2.1% and the Nasdaq Composite slumping by 2.6%.

"We expect equity markets to remain volatile as investor sentiment oscillates between hopes that the Fed will succeed in steering the US economy to a 'soft landing' and fears that it will not," said Haefele.

Stocks have been paring gains after a bear-market rally kicked off in mid-June. That jump, said the firm, was fanned by indications of economic resilience, namely an easing in inflation in July and the unexpectedly strong July jobs report. Inflation falling to 8.5% in July raised hopes of "peak hawkishness" in the Fed's monetary policy stance.

"But this optimism is fading," the Swiss wealth management firm said. Inflation still looks too elevated and the labor market is too tight and those factors should maintain the Fed's aim of keeping financial conditions restrictive to slow growth and cool the economy.

"In our view, three months in a row of core PCE of no more than 0.2% month-over-month would be the minimum requirement to support a pause in the Fed's hiking cycle," said Haefele. The Core Personal Consumption Expenditure Price Index is the Fed's preferred inflation gauge and it was up 0.6% in June on a monthly basis.

"We maintain our view that the Fed will raise rates by another 100 basis points by year-end, with risks of more hikes if inflation does not slow in line with our forecasts," UBS said.

The Federal Open Market Committee has raised the Fed funds rate four times this year to a range of 2.25%-2.5% and is widely expected to raise rates at its September 20-21 meeting. Fed Chairman Jerome Powell will speak at the central bank's annual meeting in Jackson Hole, Wyoming, on Friday.