‘The real question’ about inflation at this point, according to a market strategist

With inflation hitting a 40-year high and gas breaking $5 a gallon, all eyes are on the Fed ahead of Wednesday’s Federal Open Market Committee (FOMC) meeting.

According to Drew Matus, chief market strategist at MetLife Investment Management, the Fed addressing inflation isn’t a matter of “if” but rather to what extent for investors.

“The real question right now is: What’s going to be the cost of handling the inflation story?” Matus said on Yahoo Finance Live (video above). “I think more and more people are beginning to realize that it might come with significant economic cost.”

Following Friday’s release of May’s Consumer Price Index (CPI) data, which showed a year-over-year increase of 8.6%, markets entered a sell-off and haven’t fully recovered since then. On Monday, the S&P 500 entered bear market territory while Treasury yields rose to their highest level since 2011.

Consequently, market experts are now expecting a more hawkish response from the Fed.

“The inflation numbers on Friday really got people nervous and showed a lot of inflation in places where a lot of strategists were actually expecting inflation to roll over,” Matus said. “So that then raised the question of: How much more can the Fed do? How much more aggressive do they need to be? And maybe in the back of people’s minds, is anything the Fed [does] going to be sufficient to restrain inflation, given the fact that a lot of it is supply chain driven or coming out of energy and food?”

Despite the bleak numbers, he isn’t certain a recession will occur this year, but does anticipate it by later 2023.

“Allow margins to continue to erode over the course of this year,” Matus said. “Eventually, firms will cut back on hiring and consumers will pull back more aggressively. I think that’s pretty much the consensus among economists and strategists on the Street. And I think it’s probably one of the few times where the consensus is probably going to be right.”

A majority of economists and market experts agree with Matus’ take. According to a poll conducted by the Financial Times and the University of Chicago Booth’s School of Business, nearly 70% of the economists surveyed expect the National Bureau of Economic Research to declare a recession in 2023, though the survey was conducted prior to the May CPI data release.

A person reaches for an item at Ideal Fresh Market on June 10, 2022 in New York City amid record inflation. (Photo by Michael M. Santiago/Getty Images)

Despite the yield curve flattening, which is typically an indicator of a recession, Matus said it’s actually a sign that “markets believe the Fed isn’t going to allow inflation to remain high forever.”

“It’s holding down the longer end of the yield curve, the 10-year space, while the way they’re going to do it — i.e. hiking interest rates — is pushing up the front end of the curve,” he said, stressing that the flattening yield curve is an indicator of “faith in the Fed.”

While Fed funds futures showed a 33% chance of a 75 basis point hike this week, Matus isn’t expecting Chair Jerome Powell to surprise investors with a bigger hike, as he made it clear at last month’s FOMC meeting that the central bank was not “actively considering” a 75 basis point hike.

“If the Fed were to lose faith or people were to lose faith in the Fed, you’d see the 10-year yield moving up much more dramatically because of the inflation risk there,” Matus said.

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https://finance.yahoo.com/news/the-real-question-about-inflation-market-strategist-174522352.html

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