S&P 500 Index Faces More Headwinds as Inflation Soars, Ukraine Crisis Deepens

S&P 500 INDEX FORECAST: Bearish

  • The S&P 500 index has fallen over 11% from its all-time high amid fears about Fed tightening
  • The Ukraine crisis sent a wave of inflation around the globe, raising fears about stagflation
  • Investors will be eyeing this week’s FOMC meeting for clues about the Fed’s take on prices and geopolitical risks

The S&P 500 index – the world’s most-followed equity benchmark – has fallen over 11% from its all-time highs. While the US economy is embracing a strong post-pandemic recovery, rising inflationarypressures and the outbreak of the Ukrainewar are clouding its outlook. Surging food, energy and metal prices will likely morph into even higher costs in the months to come, urging the Fat to tighten monetary policy more aggressively. This may create headwinds for the US stock market, especially the rate-sensitive technology sector.

US CPI came in at 7.9% in February, marking the highest level since 1982. The core reading, which strips volatile food and energy items, hit 6.4%. Both figures were in line with market expectations, yet far exceeding the Fed’s long-term target of 2%. Still, they captured data from before the Ukraine war and economists now expect inflation to reach 8-9% amid the jump in crude oil, metal and food prices in recent weeks.

Economists have flagged the risk of stagflation – an undesirable situation of slow economic growth and high inflation. A rapid surge in raw material prices may dent consumer sentiment and force manufacturers to reduce capacity as their profit margins tumble. Rising fuel prices may also weigh on a wide range of sectors, from transportation to industrials. They will inevitably impact households’ everyday spending as well, pushing wage gains higher.

This may create a challenging task for central banks at the most undesirable time: the Fed is about to kick off a rate hike cycle and will start to reduce its monthly bond purchasing program soon. With inflation running high, investors may be anticipating a faster pace of rate hikes and balance sheet normalization at the FOMC meetingsfollowing the March outing. This is not good news for the stock market, as equities’ intrinsic value declines when future cash flows are discounted at higher risk-free rates. This week’s FOMC meeting will be in the spotlight as traders scrutinize the central bank’s view on geopolitical risks and high inflation.

Meanwhile, the Ukraine was is creating a lot of uncertainty and global supply chain disruptions, which investors tend to dislike. Kyiv and Mosscow had three fruitless rounds of talks so far, as the conditions Russia set for a ceasefire agreement appear to be highly contentious. It may take weeks, if not months, for both sides to get a resolution. Before that, crude oil, metal and food prices may extend higher due to supply shortages and low inventories.

US CPI vs. Core CPI (YoY)

Source: Bloomberg, DailyFX

— Written by Margaret Yang, Strategist for DailyFX.com

To contact Margaret, use the Comments section below or @margaretyjy on Twitter

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