#equity and #bondmarket have both been on a rally this year, as investors bet that the Federal Reserve may be nearing the end of its tightening cycle. The sustained liquidity that has boosted asset prices for over a decade has been reliant on a cooperative central bank. However, such optimism may be misplaced, as further declines in both equities and bonds could be on the horizon.

Market participants anticipate a sharp decline in economic growth and inflation, leading policymakers to first halt rate hikes and quantitative tightening, and then ease in an effort to support demand. But data, particularly on the employment front, suggests that the economy is still far from those conditions that would warrant such a policy shift. Despite decelerating prices, #inflation remains well above the 2% target, with elevated service wages and a rising trend in energy prices.

The outlook appears to be a period of muted #economicgrowth and persistent inflation, constituting a stagflationary regime – a challenging scenario for central banks, caught between the need to stimulate growth and control inflation. The US 10-year Treasury yield has already broken out of its downward trend, reflecting these concerns (see chart). The Federal Reserve is likely to pursue a policy of raising #interestrates well above the 5% threshold before transitioning to a neutral stance and observing the impact on the economy. This could continue well into 2024.

This policy would have negative consequences for both equities and bonds, which have thus far priced in an easier monetary environment ahead. As per the former, due to the cumulative effect of decades of index investing, a decision by equity investors in tech and other interest rate-sensitive sectors to sell could trigger a market-wide decline and possibly result in a revisit of the October lows.

Disclosure: Not investment advice. Do your own research. Hold all assets mentioned. Twitter @pietroventani for more timely comments and updates

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