Markets are starting to acknowledge the Fed is on track for a hard landing, Nomura strategist says
- Tuesday's CPI report killed expectations for a soft-landing of the economy, Nomura strategist Charlie McElligott said.
- The hot inflation reading has solidified expectations for another 75 basis point rate hike.
Stocks saw their largest one-day fall since 2020 on Tuesday, a sign that markets are starting to realize the Federal Reserve is steering the economy toward a hard landing, according to Nomura strategist Charlie McElligott.
The massive sell-off was driven by Tuesday's mixed Consumer Price Index report, which saw headline inflation cool to 8.3% in August. It's lower than July's 8.5% inflation reading – but above expectations of 8.1%.
That solidified market expectations for at least a 75 basis point rate rate hike from the Fed next week. It's also signaled that inflation may be stickier and wider-reaching than previously thought, even to Wall Street's biggest bulls, McElligott said.
"Data from last month … gave some credibility to the idea of a right-tail outcome, that there was a potential for a soft landing," McElligott said in an interview with Bloomberg on Tuesday. "The [August CPI] effectively removes that right-tail scenario, kills that soft landing dead, and in this case, now almost increases with certainty the idea of a hard landing."
He added that the Fed's nightmare scenario – a wage-price spiral and embedded inflation in the economy – could be "a very real threat," particularly given the strength of the labor market. The July jobs report showed that the economy added more than double the number of new jobs than expected, which central bankers have interpreted as a sign more economic tightening is needed.
Expectations of the terminal Fed Funds rate jumped up around 35 basis points after release of the August CPI, leading McElligott to believe the Fed will add at least one more hike than expected until March or April of next year.
That's a more aggressive approach to taming inflation, and risks overshooting on the policy rate, which could bring the economy to a grinding halt.
"Ultimately that just means [the Fed] is going to slam the brakes on the economy and increase the risk of an accident," McElligott warned.
McElligott's view is among the most bearish on Wall Street. In a note on Wednesday, analysts from JP Morgan said inflation could "resolve itself," and there was a possibility the Fed would still be able to steer away from a recession.
The next meeting of the Federal Open Markets Committee meeting will take place on September 21-22, where it is expected that the Fed will announce an interest rate increase of 50-75 basis points.
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