Comments from U.S. Federal Reserve officials indicating a significant interest rate hike is likely in the near future rattled investors’ nerves earlier in the week. Despite these concerns, the Dow Jones Index ended the week flat. Does this mean the markets have already priced in potential rate hikes? CNBC spoke with Axonic Capital Director of Research Peter Cecchini for insight on why this is likely not the case.
“The economy always feels strong like this at inflection points,” says Cecchini. “There are three ingredients that typically present themselves prior to the inception of a bear market or even a recession. One is the Fed tightening; two is some sort of price shock or commodity shock, which we are currently seeing in oil; and thirdly, some sort of systemic shock. Frankly, I think this is a rare situation where we almost have all three at the same time.”
Cecchini explains that while nominal growth may seem strong, it will likely remain insignificant. “Inflation sort of changes the way we need to analyze that data,” he adds. As a result, the markets may react in a manner that does not reflect the full picture for investors.
“It’s not unusual to have pretty convex rallies during bear markets,” Cecchini explains. “In fact, they can be some of the most tricky rallies to navigate if one is looking to hedge risk or reposition a portfolio. But I think that’s precisely what we have here. When I look across at other asset classes, for example speculative-grade spreads, they are at almost 400 basis points. I think that they are telling us something that broader equity indices are not.”
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