A ‘reverse Goldilocks’ scenario could hit asset prices amid a growing disconnect between markets and the Fed on rate cuts, strategist says

• Mismatched rate-cut expectations could lead to a “reverse Goldilocks” scenario, an HSBC strategist said.

• Strong economic fundamentals can’t coexist with the market’s aggressive rate-cut bets.

• “For us it’s not the growth side of things that is wrong, it’s the rate side that has gone a little bit too far too fast, a little bit exuberant.”

Markets think the central bank will slash rates soon — and fast. But the Fed hasn’t signaled anything remotely so dovish.

That growing discord between Fed policy and market consensus could stir a major sell-off as rate bets begin to adjust, HSBC chief multi-asset strategist Max Kettner told Bloomberg TV.

The problem is that the economic growth narrative and aggressive rate-cut expectations can’t coexist.

“I can’t have really solid fundamentals, a bit of signs that US inflation might be stickier than thought, and at the same time a rate cut in March, and in May, and in June, and so on and so on,” he said. “That sort of bites. One of them has to be wrong. For us it’s not the growth side of things that is wrong, it’s the rate side that has gone a little bit too far too fast, a little bit exuberant.”

Investors have been hoping for a so-called Goldilocks environment where conditions aren’t too hot or too cold. But if economic growth remains robust and inflation stays above target, the Fed is less likely to slash rates quickly.

In the past week, easing expectations of rapid rate cuts have pumped the brakes on the stock market rally, and a continuing re-calibration could lead to more losses.

“As that gets at least partially unwound, partially priced out, that leads to that reverse Goldilocks. And you can call it good news becoming bad news or whatever you may want to call it, and that really leads to pain across the asset classes,” Kettner said.

Speculation that the Fed could cut rates as early as March this year fueled a red-hot stock rally towards the end of last year, as softer inflation data hinted that the economy is on track to cool down.

But while stocks have seen a mild sell-off early in the new year, it’s not prompted an all-out rout across the board. Several signs in US stocks are still flashing green.

Meanwhile, investors are looking to the next consumer inflation report on Thursday, which will provide more clues on prospects for Fed rate cuts.

Read the original article on Business Insider