Morgan Stanley’s Wilson and JPMorgan’s Michele warn against QT

(Bloomberg) — Echoing nearly everyone on Wall Street, JPMorgan Asset Management’s Bob Michele and Morgan Stanley’s Michael Wilson are wary of the potential ripple effects of the Federal Reserve’s so-called quantitative tightening.

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This is revealed in the bond market. Credit spreads, typically the difference between a corporate bond’s yield and the benchmark interest rate, are still “very expensive,” Michele, chief investment officer at JPMorgan Asset Management, told Bloomberg Television on Wednesday.

“They don’t seem to be sufficiently assessing the risks of recession. By the end of the year, they will certainly return to the old highs of 600-over,” Michele said. “Also, I don’t think the markets are sufficiently pricing in quantitative tightening. This hits full force next month.”

In September, the Fed has planned to accelerate the reduction of its balance sheet to a maximum rate of $95 billion — draining up to $60 billion in bonds and $35 billion in mortgage-backed securities. As of June, the monthly cap totaled $47.5 billion. But last month, the Fed reduced its portfolio by only about $22 billion. This need to tighten policy to curb rising inflation has been a major headache facing the Fed.

Read more: Fed’s QT not going to plan: New Economy Daily

Wilson, Morgan Stanley’s chief investment officer, noted in a recent note that while the Fed stopped tightening policy before the start of an economic contraction over the past four cycles, prompting a bullish signal for stocks, current historic levels of inflation mean the Fed will likely still be tightening when a recession hits.

U.S. stocks remain stuck in a trading range with the benchmark S&P 500 swinging between gains and losses on Wednesday. The benchmark failed to break above its 200-day moving average, a technical barrier that many see as a sign of a sustained uptrend.

“The 200-day moving average is relevant because it’s the trend,” Wilson said in the same interview. “So we’re in a downtrend, and until the market can come back above that downtrend, I think making some grandiose call for new highs is, frankly, irresponsible given what’s going on with the Fed coming in and of QT. It will be much worse than what people have experienced so far.”

But some Wall Street analysts have begun to entertain the idea that the Fed will stop tightening even as recession fears grow. Not Wilson.

Read More: Morgan Stanley Sees More Fed Hikes While JPMorgan Expects Pivot

“The big change this time relative to, say, previous periods where maybe the markets got excited about a Fed pivot is this time they’re not going to unless something really bad happens, which of course it’s not going to be good for stocks,” Wilson said. . “I just think 15 years of excessive monetary policy has made the average investor complacent about that reality.”

However, Wilson offered two scenarios in which the central bank could pivot, although he stressed that it was unlikely. Either the U.S. is seeing an “inflation collapse” because there is deflation in many pockets of the economy, or the jobs data shows the nation is in a “full-blown recession where companies are actually cutting employment.”

“I don’t know where the pain point is in this for the Fed. But they don’t want to take us into a deep recession,” said Wilson, who correctly predicted this year’s selloff. “But if we got negative payroll data in the next couple of months — and that’s likely because household data is already negative — that would probably be something they would stop at. I don’t think they would start lowering rates, but they can stop. The problem with this narrative for stock investors is that it won’t be good for profits. It won’t be good for share prices.”

JPMorgan’s Michele said the central bank should provide more clarity on how aggressive it plans to be in the face of growing concerns about a recession at the Fed’s much-anticipated annual meeting in Jackson Hole, Wyoming.

“What I’m hoping for at least is that he gives us some metrics on what would cause them to stop raising rates and what would cause them to actually start lowering rates,” Michele said, referring to the president Fed Jerome Powell. . “What I think the Fed should be doing, and Powell, in particular, is taking central bank leadership on this and doing it in his own time. For God’s sake, we are facing the highest inflation in 40 years.”

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