Morgan Stanley's Lisa Shalett warned that investors shouldn't be too optimistic that the Federal Reserve can pull off a soft landing. The market believes the US central bank can bring down inflation without causing the economy to go into a recession. In a note this week, Shalett suggested to clients that they could be thinking in the wrong way. The stock market has risen even after the Fed hiked interest rates for the first time in over a year. Morgan Stanley Wealth Management CIO says that the rally is driven by higher appetite for risk. She said the developments indicate markets may be counting on a "Goldilocks" scenario where policymakers tame inflation with limited damage to economic growth and keep long-term rates low. We don't think market confidence is justified. Expectations for at least six more rate hikes are set by Fed Chair Powell. The benchmark rate is 2%.
El-Erian and other key figures doubt the Fed's ability to deal with inflation, which is at a 40-year high in the US, and many fear a recession.
The market shouldn't be so confident in the Fed's abilities.
The first is that the US stock market looks overvalued because of the low earnings yields and high price-to-earnings ratio.
The P/E ratio was 12 when consumer price inflation was between 6 and 8% in the last 70 years, compared with 20 today.
She said that the return premium that stock investors get for taking risk seems lower. There are growing risks including a maturing business cycle.
The invasion of Russia has rattled stock markets and the US has just recorded its first losing quarter since 2020.
There is a chance that markets are not pricing in the impact of the Fed cutting back on asset purchases.
The central bank is going to keep interest rates low in order to sustain the economy during the Pandemic. It hasn't laid out its intended timing or pace.
Financial conditions have already tightened. At least $560 billion is expected to be withdrawn over the year, equivalent to another rate hike.
Execution risk is high because the Fed has limited experience with these operations.
The Morgan Stanley CIO abandoned its last balance-sheet reduction move when markets turned volatile.
There are hopes in the market that the Fed will intervene to limit a slide in stocks once they fall to a certain level.
The tone from officials, who could be eyeing hikes of 50 rather than 25 basis points, may be misguided.
It is possible that some of this positioning may be politically driven, but there is a growing possibility that the central bank will need to prioritize inflation over markets.
Morgan Stanley expects the rate to go up in May and June. It sees a bumpy path ahead and policymakers rethinking whether a soft landing can be engineered.
Shalett said that investors should consider growth companies.
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