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The shift in S&P 500 sentiment late last year appears to have been more than just the result of “tax loss harvesting,” in which investors sell stocks at a loss to offset taxes on capital gains.
The lingering pessimism could indicate concern about future uncertainty. Yes, the U.S. economy and labor market remain resilient, but this is not the best news in the context of ongoing battles against inflation.
Investors seem worried that Trump’s policies could spur economic growth, which might lead to higher inflation (with the trade war adding more complexity), making the Fed’s task even harder.
Keep in mind that during the December meeting, the Fed already revised its forecast from four 25-basis-point rate cuts to just two, as the disinflation trend appears to be losing steam.
Now, with the unemployment rate dropping to 4.1% from 4.2% in November and 256,000 new jobs added (versus 164,000 expected), there are talks that the Fed may not cut rates at all this year.
The recent rise in energy prices, triggered by the latest sanctions imposed on Russia, also raises concerns that inflation will pick up again, which would keep the Fed’s monetary policy on hold.
If that were actually the case, there would be two main problems: first, it would mean that business borrowing costs would remain high, and second, the government’s debt servicing costs would rise.
This is partly because Trump’s initiatives will need more funding at market rates, and the Treasury issued short-term primarily debt during the pandemic, which it will now have to refinance at much higher rates.
Some argue this could lead to significant financial challenges later on, including the need to reform programs like Social Security and Medicare. Also, the Fed may have to intervene in the open market.
Now, as for what to expect from the market, it will depend mostly on how this week’s inflation data comes out, with the release of PPI on Tuesday and CPI on Wednesday.
Worse-than-expected figures would reinforce fears that the Fed may not cut interest rates or may even have to raise them. As a result, Treasury yields would soar, putting pressure on the stock market.
