Stocks rally as odds of U.S. Fed going bigger come down

Rita Nazareth, Bloomberg News

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The stock market snapped back at the end of a dizzying week as traders reduced their wagers on a bigger Federal Reserve hike in July, while parsing a raft of Wall Street earnings and hoping for signs of capitulation that could set the stage for a more sustained recovery.

American equities halted a five-day slide, with the expiration of about US$1.9 trillion in options. Banks led gains after Citigroup Inc.’s blowout results. Swaps are pricing in nearly 75 basis points of Fed tightening this month -- still an aggressive boost that leaves investors wondering about the odds of a recession, but down from a full-point bet earlier this week. The dollar and bond yields fell.

Economic readings were all over the place, but it was a drop in US consumer long-term inflation expectations to a one-year low that effectively captured traders’ attention. The reason is that it may provide some solace to policy makers that price pressures aren’t becoming entrenched.

Another reason for hope is that two Fed officials didn’t sound too keen on a full-point hike in July. Atlanta Fed President Raphael Bostic voiced wariness about a super-sized increase, and St. Louis’s James Bullard said he would defer judgment to the central bank’s meeting. He was quoted earlier this week as saying he favored sticking with a 75-basis-point boost.

“While a recession is increasingly likely, bulls note that a lot of bad news is already being priced in, and if a recession is shallow, there is upside to markets over the next year,” said Mark Hackett, chief of investment research at Nationwide. “The path to get there may not be pleasant, but if earnings can hold up, there is reason for cautious optimism.”

Odds are now close to even that the US will slip into a recession within the next year. The probability of a downturn over the next 12 months stands at 47.5 per cent, up sharply from 30 per cent odds in June, according to the latest Bloomberg monthly survey of economists.

US stocks could see more declines as the risk of a hard economic contraction and a stronger dollar rises in the second half of the year, according to Bank of America Corp. strategists. Equity markets could see “proper capitulation” if second-quarter earnings are worse than expected, Michael Hartnett wrote.

“The markets today reflect a slowdown or a mild recession already,” said Kara Murphy, chief investment officer at Kestra Holdings. “As soon as we have confirmation that the Fed is winning the war with inflation -- that means we need to see multiple data points suggesting that prices are slowing -- I think that will be a risk-on sign for the market.”

In other corporate news, Wells Fargo & Co. said it will continue to do share repurchases, but it’ll be “prudent,” even as its peers JPMorgan Chase & Co. and Citigroup have both announced plans to pause buybacks. UnitedHealth Group Inc.’s results were lifted by lower costs of care that portend well for other health insurers.

Bullish positioning on the US dollar has surged to its highest level in seven years while investors have amped up their bearishness on the euro and turned against emerging-market currencies, according to a BofA survey of fund managers.

Elsewhere, oil clawed back some of its weekly losses. Wheat futures erased their gains for the year in Chicago, as prospects for weaker demand offset supply worries that were exacerbated by Russia’s invasion of Ukraine.

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