Equity markets experienced another day of sustained sell-off on Friday as investors remain wary of rising inflation rates. In May, inflation rose by 8.6% year over year marking the fastest increase since December 1981. The consumer price index or CPI which measures the prices of goods and services increased higher than estimates of 8.3%, dragging equity indices lower.

The S&ampP 500 fell by 2.9% on June 10 which means it is now inching closer to bear market territory as the flagship index is down 18% from all-time highs. A bear market is defined as a drop of more than 20% from record highs.

The CPI rose 1% compared to April as energy prices were up 3.9% in this period. In 2022, energy prices have already surged by 34.6% acting as a key catalyst to inflation. Investors will be closely watching the Federal Reserve’s decision to hike interest rates in the upcoming week. 

Jerome Powell, the chairman of the Fed, will brief the press on Wednesday, after a two-day meeting. The Central Bank is expected to increase interest rates by 0.5% but will policymakers take an aggressive stance given challenging macro-economic conditions.

New economic and interest rate forecasts will be released by the Fed on Wednesday at 2 pm EST but the press conference will provide details on upcoming hikes which could further derail the stock market.

In addition to the Fed meeting, investors will brace for other economic reports such as the producer price index on Tuesday, retail sales data on Wednesday, housing starts on Tuesday, and industrial production on Friday. Tech giant Oracle (NYSE: ORCL) will report its quarterly earnings on Monday.

 

Interest rate hikes might lead to a recession

Market participants are waiting to see if accelerated interest rate hikes will lead to an economic recession. Historically, higher interest rates shift investment capital towards lower-risk investments such as bonds. As borrowing costs for corporates increases, their earnings will compress leading to lower valuations. Further, rising inflation numbers will result in a fall in consumer spending, negatively impacting the top-line of companies.

Investment banks including Barclays (NYSE: BCS) and Jeffries now expect interest rates to rise 75 basis points or 0.75% while Goldman Sachs (NYSE: GS) estimates an additional interest rate hike of 0.5% in September. JP Morgan (NYSE: JPM) has forecast the fed funds rate to rise to 2.625% in 2022, up from its previous guidance of 1.875%.

Treasury yields rose after the inflation report was released on Friday while the yield curve has flattened. It means shorter duration yields such as the 2-year Treasury yield have inched closer to longer duration yields including the 10-year Treasury yield. The 2-year Treasury yield stood at 3.06%. If the 2-year yield rises above the 10-year yield, the curve would be inverted which has historically been a signal for a recession.

In past bear markets, the S&ampP 500 declined on an average of 32%, and in the last financial crash of 2008-09, it declined by 56%.

According to an RBC analyst, there is a 60% chance the market might have set a bottom. The valuations are reasonable enough, suggesting you can go bottom fishing and buy shares at a discount.

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