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NEW YORK: Investors' faith in a soft landing for the U.S. economy is being heavily tested, as a jumbo-sized interest rate hike from the Federal Reserve stirs worries over recession and more volatile trading ahead.
Analysts and investors said they believe a recession is more likely after the Fed at the close of its policy meeting on Wednesday hiked rates by 75 basis points – its biggest raise in nearly three decades – and committed to delivering more big moves to fight surging inflation.
While stocks rallied on hopes that the Fed is willing to go all out in fighting the worst inflation in more than 40 years, few believe that deep selloffs in equities will be near a turning point until there are clear signs inflation is ebbing. The S&P is down 22.2% year-to-date and is in a bear market.
“Volatility is going to stay high, which makes market participants including myself less interested in taking risk in general,” said Steve Bartolini, a bond fund manager at T. Rowe Price.
Wednesday’s rate hike was accompanied by a downgrade to the Fed's economic outlook, with growth now seen slowing to a below-trend 1.7% rate this year. Analysts have been debating whether the Fed will hit a "hard landing" by putting the economy into recession as it hikes rates, or whether it can dampen inflation while slowing growth, meaning a "soft landing."
U.S. central bank officials flagged a faster path of rate hikes to come, but although another three-quarters of a point increase at the central bank's next meeting in July is possible, Fed Chair Jerome Powell said such moves would not "be common."
Despite Powell's confidence that policymakers could engineer a soft landing, others were less confident that the economy would emerge unscathed from what is on track to be the sharpest tightening cycle since 1994. Analysts at Wells Fargo said on Wednesday that odds of a recession now stand at more than 50%. Other banks that have warned of rising recession risks include Deutsche Bank and Morgan Stanley.
Indeed, investors are already saying that recession risks could see the Fed soon reverse course. ING analysts said in a note that moving "harder and faster comes at an economic cost" and that rising recession risks "mean rate cuts will be on the agenda for summer 2023."
A recession could mean more pain for an already-battered stock market. Bear markets accompanied by recession tend to be longer and steeper, with a median decline of about 35%, data from Bespoke Investment Group showed.
"If we end up in a recession later this year or early next year, earnings would decline on equities and stocks would probably go down further," said Sean McGould, president and co-chief investment officer at hedge fund firm Lighthouse Investment Partners.