It isn’t a bullish sign for the stock market that the Federal Reserve is still chasing “an elusive soft landing” for the economy more than a year into its battle against high inflation, according to economists to Mizuho Securities.
The Fed already lifted its benchmark interest rate to a 5%-5.25% range in roughly the past year, bringing its benchmark rate to the highest level since 2007.
But with the Fed still penciling in two more potential rate hikes for 2023, as elements of inflation remain “sticky,” (see chart) or tough to cool, the Mizuho team thinks the result will be more damage on the economy than investors currently expect, while the central bank works to bring the cost of living back down it 2% yearly target.
At the same time, U.S. stocks have been “priced for a perfect soft landing” for the economy, said Mizuho Securities economists Steven Ricchiuto and Alex Pelle, in a Tuesday client note.
They pointed to forward expectations of 12% earnings growth in 2024, after a “disappointing” 1%-2% advance this year, suggesting “the market is discounting that the worst of the economic slowdown has already transpired.”
However, their view is that a soft landing scenario being discounted by equity investors looks “extremely difficult to accomplish,” with a long and shallow recession beginning early next year a more likely outcome.
Related: Fed’s Williams says economy won’t hit its weakest point until next year
The S&P 500 index
SPX,
rose 0.7% on Tuesday to 4,439, and about 15.6% higher on the year so far, according to FactSet. The two other major U.S. stock indexes also posted gains ahead of Wednesday’s release of the June consumer-price index, a key inflation gauge. The Dow Jones Industrial Average
DJIA,
was up 3.4% for the year through Tuesday, while the Nasdaq Composite Index
COMP,
advanced 31.5% to date in 2023, according to FactSet.
“Although the Fed appears to be attempting a soft landing, a recession is more likely and the risk is that a deeper, more protracted recession is required,” the Mizuho economists wrote. “As such, we continue to argue against the consensus bull market call and see a correction back below 4100 as the most likely scenario.”
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