Fed may pause rate hikes on inflation, growth data, strategist says

Frances Newton Stacy, Optimal Capital Director of Strategy, and
Kevin Nicholson, RiverFront Investment Group Global Fixed Income Co-CIO, joins Yahoo Finance Live to recap the markets on Feb. 9.

Video Transcript

[MUSIC PLAYING]

BRAD SMITH: Welcome back to Yahoo Finance Live, everyone. Major averages pointing towards a higher finish across the board and trying to add on to the consecutive days of gains. I'm Brad Smith, here with Emily McCormick. And standing by for the analysis after the bell, we've got Frances Newton Stacy, Optimal Capital Director of Strategy, and Kevin Nicholson, RiverFront Investment Group Global Fixed Income CIO. Great to have you here, both with us.

We're going to get into some of the analysis after the bell. But right before then, let's just take another look at where we are standing going into that closing across the Dow Jones Industrial average. You're seeing that right now.

Still holding onto gains of about 8/10 of a percent. The S&P 500 also in positive territory by about 62 points, 1.4% we'll round that off to. And the NASDAQ composite seeing gains of 2% on today's activity, 288 points in positive territory with just seconds left.

Also here, let's take a quick look at the sectors. You've got 10 out of 11 S&P 500 sectors in positive territory on the day. The only laggard-- consumer staples. However, the gains are coming in from communication services, real estate, and technology. And then just lastly here, the biggest Dow components that we're seeing moving-- Disney ahead of their earnings results, coming after the bell. Let's take a live look at the closing bell today.

[MUSIC PLAYING]

[BELL RINGING]

[MUSIC PLAYING]

EMILY MCCORMICK: And there you have it. That is the closing bell this Wednesday, February 9. Taking a look at where stocks are going to settle on today's session, the Dow Jones Industrial average up more than 300 points, or about 9/10 of a percent. The S&P 500 up about 1.5%. And the NASDAQ composite up about 2%. Those technology shares are extending gains, accelerating here into the close, as we have seen Treasury yields easing back across the yield curve.

But let's head back over to our market panel now for a little bit more analysis on today's trading action. Frances, I'll start with you. Now, we're heading for a third straight week of gains for the S&P 500 after a month-long stretch of volatility. Do you think this momentum can continue?

FRANCES NEWTON STACY: Well, I think that it can continue a little bit higher. I think what I expect at this point is for the S&P to go back up and test 46, 87, 50, that range. It's either going to make a lower high and fail. It's going to go back up to the all-time high or very near it and have a double top. Unlikely, I don't see a catalyst yet. It could go and make a slightly higher high and then probably fail.

And the reason is, is that growth and inflation look like they're peaking, particularly inflation. While the CPI print is expected to be very hot tomorrow, it's going to be very interesting to see if we have a deceleration in the month-over-month numbers versus even higher year-over-year numbers. Of course, any surprises, markets are going to react to that.

But the thing is, is if you look at the data in the background, what supports the peak inflation narrative is the ISM numbers are coming off of their peaks. You know, when you're looking at the growth story, you've got the impossible comparisons of the $1,400 stimulus checks from last year. And so you see these things in a deceleration pattern. And then you sort of juxtapose that to the hawkish pivot from the Fed. And you look back, historically, every time the Fed has tightened into decelerating growth, you've had a recession as a precursor.

Even though the market has now priced in five rate hikes-- which is why I think that we have this nice bounce, is because we've now priced in the bad news-- I think many traders, and particularly those looking at the gap between the inflation consensus and the swap market, are saying, wait a second, I don't know that we're going to get five rate hikes in. And that could be some of what's behind the rally.

BRAD SMITH: And Kevin, behind each decision, you know, piggying back off of what Frances was saying a moment ago, with each of the decisions that the Fed makes, how data dependent do you expect them to be along the way of these hikes that we're already anticipating?

KEVIN NICHOLSON: I believe that the Fed is going to be very data dependent. And so that's-- I agree with pretty much everything that Frances said, because the Fed, at this juncture, is behind the curve. So initially, you know, they're going to make sure that they get a couple hikes in.

But then they're going to look at the data as it comes in. And if it shows that the economy is actually slowing down and that they are getting inflation in check, then I believe at that juncture they may take a break and pause. And so we may not see the five rate hikes that actually that the Fed funds futures market is pricing in right now.

EMILY MCCORMICK: Frances, you mentioned the CPI print that we'll be getting out tomorrow. What do you think the market is pricing in at this point? And if we do get another print above 7%, or a print above 7%, accelerating from what we saw in December, do you think that's going to stir up some volatility here in markets?

FRANCES NEWTON STACY: Well, the thing is, is that I think if it comes out as expected, we're not going to have much, because I think a lot of it's been priced in. However, if we do see a surprise to the upside, we might have something. But again, you've got more data coming out again. You've got another print coming out before the Fed meets in March. So I don't know how much it would influence the Fed.

However, if it surprises to the downside, I think you may see a really positive reaction in markets if it's way down, because there again, you know, what we're saying is basically, do we get five rate hikes in? And is that currently probably what's priced into the market? I think 5.3 or something is priced into the market at this point.

So the other thing is that when you look at credit spreads, credit spreads are kind of building in the background, which is sort of along that peak inflation sort of deceleration story. And the thing about it is, is when you look at, like, for instance, the corporate bonds, you know, when you look at where Powell pivoted in 2018 when they weren't able to tighten as much as they wanted to tighten, we are not that far away from that.

So anything that gets even like it's looking like it's going in that direction, people are going to assume that Powell is not going to want to live through that again, because remember, it wasn't just the 20% sell-off in 2018. It was the liquidity issue in the overnight markets. When those rates spiked in September, that sort of was around the corporate tax payment where there was a liquidity issue in the system. And that started the quantitative easing back up and running before COVID.

So we're not that far away from that if these credit spreads widen any further. And the thing about it is we have way more debt in the system than we had at that time. So Powell is going to be very sensitive to that.

BRAD SMITH: Kevin, where would you be positioning your portfolio at this time? I mean, the biggest sectors that we've seen, at least during today's trading session, in some of the gains that came through-- communication services are one of the major sectors and one of the major outperformers that we've been tracking. But we also have been keeping a close eye on staples and where some investors have been leaning further into staples at this point in time. Where would you be positioning?

KEVIN NICHOLSON: So it really depends on the time horizon that you have before you. Our portfolios are positioned along-- in time horizon basis. And so in our longer-horizon portfolios, we have been focused on buying mega-cap tech on the pullback. We've also bought some comp services in those portfolios.

We also like consumer discretionary, because we think that with wages rising, with the economy reopening, and hopefully we're getting past the pandemic, that people are going to have some extra discretionary income. And also, because interest rates have been rising, we have liked financials as well.

Now, staples has actually started the year out very strong. Staples were good for the risk-off market. But as we go forward and we get away from risk off, I think that, you know, staples are going to lag some. And there's going to be a give back. So that is a place that we will be moving away from in our portfolios.

I think that when you think about the fixed income side of the equation, because we run a balanced portfolio, we're going to continue to reduce the duration in our portfolio. So we're going to be focused more on having, you know, investing in the front end of the curve, that one to five-year part of the curve, in short-term corporates, especially short-term high yield at this point, as it's yielding over 5%. And bank loans, because it resets on a quarterly basis, so that gives you an opportunity to stay current with your coupons. And it's higher up in the capital structure.

EMILY MCCORMICK: And Frances, for you, how are you positioning and advising investors to be positioned for the potential moves that we may be seeing out of the Fed, the potential for inflation to be sticky throughout at least the first half of this year? Where are you seeing opportunities right now?

FRANCES NEWTON STACY: Well, I think in the short term, you know, he's absolutely right. I think in the longer term, though, we are looking to get more defensive, again because we think that some of these-- the comparisons in growth, the fiscal drag to growth rate. If the law doesn't change from where we are now, you're going to have $1.3 trillion year over year less in fiscal spending. And so that's going to take a bunch of points out of the GDP.

So we actually think that the decelerating GDP number could come in a lot less than even some of the worst estimates. So when you see inflation backing off, potentially, from where it is now, getting into sort of the 3's and the 4's, and you see growth backing off-- and you know, we could see, optimistically, 3 or something like that on growth, but it could be less depending on the fiscal drag simultaneous to the tapering, simultaneous to potentially, you know, rate hikes, and potentially balance sheet reduction, right? That's a lot of catalysts coming out of the system.

When you look at earnings and you look at profits and you look at those margins, they're already decelerating. And then you've got the lagging indicator of the wages going up. And so they're going to put more pressure on the margins as everything starts to roll over. So that's going to be very hard on companies.

So I don't think it's too early to get pretty defensive I think we do still have some potential downside with duration. But again, just putting that insurance in, because once this thing takes off and rolls over, it's better to be upside down for five minutes than late, because it's hard to catch.

BRAD SMITH: Frances Newton Stacy, Optimal Capital Director of Strategy, and Kevin Nicholson, RiverFront Investment Group Global Fixed Income CIO. Thank you so much, both, for joining us here today.