Traders work on the floor of the New York Stock Exchange during morning trading on May 17, 2023 in New York City.
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According to Michael Yoshikami, founder and CEO of Destination Wealth Management, a US recession could prevent a sharp market downturn in the second half of 2023.
US CPI inflation fell to 4.9% yoy in April, the lowest annual reading since April 2021. Markets took new data from the Department of Labor earlier in the month as a sign that the Federal Reserve’s efforts to contain inflation are finally bearing fruit.
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The headline consumer price index has cooled significantly since peaking above 9% in June 2022, but is still well above the Fed’s 2% target. The core CPI, which excludes volatile food and energy prices, rose 5.5% annually in April amid a resilient economy and persistently tight labor markets.
The Fed has consistently reiterated its commitment to fighting inflation, but minutes from the Federal Reserve Open Market Committee’s most recent meeting showed officials divided over how to approach interest rates. They eventually opted for another 25 basis point hike, raising the Fed Funds target rate to between 5% and 5.25%.
Chair Jerome Powell suggested at the FOMC FOMC meeting in June that a pause in the rate hike cycle was likely, but some members still see the need for more rate hikes, while others believe a slowdown in growth is the need will make further tightening superfluous. The central bank has hiked rates 10 times since March 2022, totaling 5 percentage points.
Still, the market is pricing in rate cuts by the end of the year, according to CME Group’s FedWatch tool, which assumes a nearly 35% probability of the year-end target interest rate ranging from 4.75% to 5%.
By November 2024, the market is pricing in a 24.5% chance – the peak of the bell curve distribution – that the target rate will be lowered to the 2.75% to 3% range.
Speaking to CNBC’s Squawk Box Europe on Friday, Yoshikami said that could only happen in the event of a prolonged recession, which he said is unlikely without further tightening of policy as falling oil prices continue to boost economic activity.
“This may sound crazy, but unless we get into slower economic growth and maybe even a shallow recession in the United States, that could actually be viewed as a negative because interest rates might not be cut or might even continue to rise.” the case is. That’s the risk for the market,” he said.
Yoshikami anticipates that more companies will start to make the market more conservative about expected earnings as they anticipate borrowing costs to remain high for longer and margins to shrink.
“For me it all boils down to, ‘Is the economy going to go into recession?’ Believe it or not, when that happens I think it will be good news,” he said.
“If the economy avoids this and continues on its rapid trajectory, I think we’re going to have some issues in the market in the second half of the year.”
Federal Reserve officials, including St. Louis Fed President James Bullard and Minneapolis Fed President Neel Kashkari, have in recent weeks hinted that sustained core inflation could keep monetary policy tight for longer and more this year could necessitate rate hikes.
Yoshikami said the actual process of cutting interest rates was a “drastic step” despite market prices, and suggested that policymakers could try to “massage” market expectations in a certain direction through speeches and public statements, rather than committing to definitive policy action in the short term seize.
Due to the uncertain trajectory of monetary policy and the US economy, the veteran strategist warned investors to be “skeptical” about valuations in certain segments of the market, particularly in the technology and artificial intelligence space.
“Think about it, look at it for yourself, and ask yourself, is this a reasonable stock given what we think earnings will be over the next five years?” If not, put an optimism premium on that asset. “You’d best be very sure about that because that’s really where the tears come,” he said.