The Federal Reserve will likely keep working to convince equity investors that expectations are being priced in "too aggressively" for when the central bank will start raising interest rates and how fast those changes will occur, according to the US head of stock trading at Barclays.
The Fed's two-day meeting starting on March 16 will be held at a time of notable rotations in equity markets, spurred in part the quick rise in borrowing rates this year as tracked by some Treasury yields. Yields have pushed higher in part as investors anticipate a rise in inflation as the US economy recovers from the COVID-19 health crisis.
As yields climb, so do expectations for when the Fed will start raising its benchmark interest rate which currently sits at a range of 0%-0.25%.
Growth in the world's largest economy is a supportive factor for stocks, and rising rates to reflect growth "shouldn't be a headwind for equities," said Michael Lewis, head of US cash equities trading at Barclays, during the bank's teleconference about inflation on Tuesday.
But "the velocity of the move in rates that we saw, or the rate of change in the move that we saw, spooked equity investors," he said.
Lewis said he recalled at the start of 2021 seeing about 31.5 basis points of rate hikes priced into year-end 2023, "and then we went almost to above 90 in just a handful of weeks. That's a massive move in terms of what people are expecting the Fed to do, what the market is pricing in," he said. "And if you are going to get hikes to that degree and velocity and in that timeframe, that is negative for equities."
However, "if you look at the dot-plot, there's no liftoff expected through 2023, it's in 2024," he said. The dot-plot is the Fed's way of signaling its interest-rate outlook.
"So the real job...is for the Fed to walk people off that cliff," he said, adding that a lot of the central bank's commentary so far "hasn't been successful in convincing the markets that they are pricing in these expectations a little too aggressively."
Lewis expects the Fed "will find a way to walk that back", including discussing at next week's meeting its preferred inflation measure, the PCE price index. That index "is a good 30 to 40 [basis points] lower" than the consumer price index. Also, the Fed can discuss near-term inflation versus longer-term inflation, he said.
Looking ahead, Lewis said he expects investors to continue to see large-cap tech and growth stocks underperform over the course of the next 12 to 18 months in favor of more cyclical-type stocks.
"But given the velocity and the rate of change that we've seen in the rates market ...counterintuitively over the next week or two if you see a bounce in equity markets, it's going to be led by growth and tech," because of their recent and steep selloffs, he said.