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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A recession in the United States could prevent a sharp market slowdown in the second half of 2023, according to Michael Yoshikami, founder and CEO of Destination Wealth Management.
U.S. consumer price inflation slowed to 4.9% year-on-year in April, its lowest annual pace since April 2021. Markets took the new Labor Department data earlier this month as a sign that the Federal Reserve’s efforts to rein in inflation are finally paying off. fruit.
The headline consumer price index has cooled considerably since peaking above 9% in June 2022, but remains 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 still tight labor market.
The Fed has consistently reiterated its commitment to fighting inflation, but minutes from the Federal Open Market Committee’s last meeting showed officials were split on where interest rates should go. They eventually opted for another 25 basis point increase at the time, bringing the target federal funds rate between 5% and 5.25%.
Chairman Jerome Powell hinted that a pause in the bullish cycle is likely at the June FOMC meeting, but some members still see the need for further hikes, while others foresee a slowdown in the growth will remove the need for further tightening. The central bank has raised rates 10 times for a total of 5 percentage points since March 2022.
Despite this, the market expects price declines by the end of the year, according to CME Group’s FedWatch tool, which places a nearly 35% probability on the target rate ending the year in the range of 4.75 to 5%.
By November 2024, the market is pricing in a 24.5% chance – the top of the bell curve distribution – that the target rate will drop to the 2.75-3% range.
Speaking to CNBC’s “Squawk Box Europe” on Friday, Yoshikami said the only way to happen is in a prolonged recession, which he said is unlikely without further policy tightening, as the fall oil prices further stimulate economic activity.
“It’s going to sound crazy, but if we don’t go into slower economic growth in the United States and maybe even a shallow recession, that could actually be seen as negative because interest rates could not be reduced or may even continue to decline. if so. That’s the risk to the market,” he said.
Yoshikami thinks more companies will start guiding the market more cautiously on forward earnings in anticipation of borrowing costs staying higher for longer and compressing margins.
“For me, it’s really going to come down to ‘is the economy going to touch close to a recession? Believe it or not, if that happens, I think it will be good news,” he said.
“If the economy avoids it and continues on its foamy path, then I think we are going to have problems 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 indicated in recent weeks that persistent core inflation could keep policy going. tighter monetary policy for longer and may require more hikes this year.
Yoshikami said the actual rate-cutting process would be a “drastic step” despite market prices and suggested policymakers could try to “massage” market expectations in a certain direction through speeches and statements. public, rather than definitive political action in the short term.
Due to the tenuous trajectory of monetary policy and the US economy, the seasoned strategist warned investors to be “skeptical” of valuations in certain parts of the market, particularly technology and AI.
“Think about it, look at it yourself and ask yourself this question: Is this a reasonable stock given what we think earnings are going to be for the next five years? If not , you’re putting an optimism premium on this asset that you better be awfully sure about because that’s really where the tears come from,” he said.