Investors should “resist chasing reflexive rallies” in the stock market as it’s uncertain whether the Federal Reserve will be able to engineer a soft landing for the economy while fighting hot inflation, according to Morgan Stanley Wealth Management.
How consumers choose to spend will have “profound implications for both growth and inflation,” she said. The potential for “a revival in services consumption” plus a decline in goods demand may lead to “negative earnings surprises” for companies as they rebuild their inventories in the pandemic, according to her note.
Meanwhile, the bond market sees “increased chances for a policy mistake” by the Fed, she said, pointing to the flattening of the U.S. Treasury yield curve. “There is little debate even among Fed governors that the central bank is ‘behind the curve’ in fighting inflation,” Shalett wrote. Investors have been watching the yield curve for inversion as that historically has preceded a recession. The yield curve spread between 2-year and 10-year Treasurys traded around 18 basis points on Monday, flattening from about 0.30 basis points on March 15, the day before the Fed announced its first rate hike since 2018, according to data from the Federal Reserve Bank of St. Louis.
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