Traders are in a heated debate about the impact of the Ukraine crisis on Fed monetary policy, energy prices, and the effects the incursion could inflict on the economic expansion story. A minority of traders feel that with such large geopolitical risks, the Fed should delay making major policy decisions.
The problem is, the Fed was dealing with a major inflation problem prior to this, and the Ukraine crisis is only exacerbating the inflation problem. Most believe the Fed has no choice but to stick to its plan to raise rates beginning in March but seeing a 50-basis-point hike is now unlikely.
Goldman Sachs’ Jan Hatzius reflected this majority viewpoint in a note to clients: “We do not expect geopolitical risk to stop the FOMC from hiking steadily by 25bp at its upcoming meetings... We suspect that some participants will see it as a compelling reason not to hike by 50bp in March.”
Current factors align poorly for stocks
The reason the market has been selling off is that there is a combination of factors that historically has proven to be very negative for stocks:
- Higher inflation: Stocks do well during modest inflation, but periods of rapid inflation make it difficult for corporations to consistently raise prices.
- Slower growth: The U.S. is nowhere near a recession, but higher commodity costs, particularly oil, are going to slow U.S. growth.
- Fed tightening: While slow rate hikes in a strong economy are not necessarily negative, rapid rate hikes into a weaker economy is historically a headwind for markets.
- Higher Energy Prices: The price of a barrel of oil has surpassed $105 which hasn’t been seen since 2014. Russia’s grip over Europe has caused many countries into a full-blown energy crisis.
- Retail Sentiment - Extreme Bearishness (Source: American Association of Individual Investors):
- Bullish 23% (historic average: 38%)
- Bearish 54% (historic average: 40%)
- Neutral 23% (historic average: 31%)
- Investors Pull Billions from Bond and Money Market Funds: $134 Billion exited money market funds in January and bond funds saw outflows top the March 2020 pandemic exodus as investors appear to be reacting to inflation and the likely impact of higher rates in the coming months.
Some good news!
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