- The Federal Reserve will likely follow in the footsteps of the Bank of England and pivot, according to Morgan Stanley.
- The bank said global US dollar liquidity was now in the “danger zone where bad things happen.”
- But equity investors shouldn’t get too excited about a Fed pivot because an earnings slump is imminent, Morgan Stanley said.
It looks increasingly likely that the Federal Reserve will move away from its currently hawkish monetary policy as global U.S. dollar liquidity is now in the “danger zone where bad things happen,” said Mike Wilson of Morgan Stanley in a Monday note.
Just as the Bank of England had to step in last week by buying long-term bonds to stem soaring gilt yields, the Fed will likely have to step in the same way, whether that means a pause in rate hikes or full quantitative easing. .
“The first question to ask is when does the US dollar become a problem for the United States? Nobody knows, but more price action like the one we have seen will eventually push the Fed back. “Wilson said.
But investors shouldn’t invest too much in a potential Fed pivot, he added. Indeed, an earnings recession is imminent and the potential decline in the stock market due to a large decline in earnings would likely outweigh the potential upside of a Fed pivot.
According to Wilson, the drop in earnings will be due to several macroeconomic risks that companies have been forced to manage in recent months, including COVID lockdowns in China, the surging US dollar, rising interest rates and weak currency. European economy.
“We suspect that the uncertainty these factors foster will lead to both revisions and lower forecasts, two headwinds for forward earnings estimates,” Wilson said. And the expected drop in earnings expectations could be significant because so far, forward earnings estimates have only fallen 1% since mid-June.
“It takes a long time for the next twelve-month EPS to decline for the S&P 500 because it is a very high-quality, diversified index and companies are loath to throw in the towel on the quarters ahead until they have to. It seems like more companies have reached a point where they can’t fight anymore,” he explained.
Wilson would like the S&P 500 EPS forward estimates to fall to $225 or less, combined with a rise in the equity risk premium or lower ISM PMI, before making sure that a sustainable bottom has been achieved in the stock market. The forward EPS estimate for the S&P 500 is currently $237.
“Bottom line, in the absence of a Fed pivot, stocks are likely heading lower. Conversely, a Fed pivot, or the anticipation of such a pivot, can lead to a strong rally, especially since we are so oversold… Just keep in mind that the light at the end of the tunnel that you might see if this happens is actually the freight train of the impending earnings recession that the Fed can’t stop at this point,” Wilson concluded.