Ignore a more hawkish Federal Reserve at your own peril, warns RBC Capital Markets head of U.S. equity strategy Lori Calvasina.
“They [our strategists] think the market is too sanguine. They think people are underestimating the number of hikes in 2023 and how high the Fed could ultimately go,” said Calvasina on Yahoo Finance Live.
The markets have rallied back to within all-time highs this week as traders push aside a shift in the tone by Federal Reserve chief Jerome Powell just one week ago. Instead, investors are taking their cues on positive news on the Omicron variant from the likes of Pfizer (vaccine holds up well if given three doses) and emerging studies that show the variant is less lethal than expected to those vaccinated.
Amid the latest risk-on rally that has lasted the better part of four sessions, investors have aggressively bid up re-opening stocks such as Carnival Cruise and Delta Air Lines.
But the rally may be put to the test starting on Friday as Wall Street consensus thinks the headline Consumer Price Index (CPI) may show a startling increase near 7%. In turn, that would possibly reignite the debate on the Fed having to end its bond buying program earlier than expected or lift interest rates in 2022 to stomp out inflation.
Some are already betting on this happening, even if the broader equity market is ignoring it.
Deutsche Bank strategist Jim Reid notes the odds of an interest rate hike from the Fed in May 2022 now stands at 78.8%, up from a 66.1% probability seen just before Omicron variant fears took hold on Black Friday.
Says Calvasina, “Over the course of a few months, markets will have to come to terms with a Fed that is tightening a little more aggressively than what they had been positioned for.”
Calvasina is telling clients the best way to play the shift in the Fed — and potential additional market volatility — is to invest in value stocks.