The US stock market will reach a key inflection point tonight that could set the tone for ASX shares for the rest of the year.
The US Federal Reserve will be handing down its interest rate decision on Thursday with the market fully pricing in a 75-basis point (bp) hike.
If that comes to pass, it will be the Fed's third three-quarter point hike and would lift the Fed Funds Rate from 3% to 3.25%. That would be the highest since the start of the GFC in 2008!
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What is spooking the US stock market?
But the Fed could be even more aggressive. The futures market is pricing in a 16% chance that the Fed could hike by a full percentage point, reported Reuters.
The US stock market is on tenterhooks. Investors are split over whether the Fed will hike rates to a point that will trigger a recession.
Adding to the angst is the prediction by "Dr. Doom", Nouriel Roubini, that the US and the world is facing a "long and ugly" recession, reported Bloomberg.
Dr. Doom's warning of a 40% crash in the US stock market
In fact, the economist believes the S&P 500 Index (SP: .INX) will crash by 40% if the US economy comes in for a hard landing. Make no mistake, the S&P/ASX 200 Index (ASX: XJO) won't be spared even if our economy holds up better.
Roubini correctly forecasted the GFC to earn his nickname. He said:
Even in a plain vanilla recession, the S&P 500 can fall by 30 per cent…It's not going to be a short and shallow recession, it's going to be severe, long and ugly.
How high can the Fed go?
His pessimism is premised on the Fed hiking rates to a peak of 5% in this cycle. That's well above expectations that the central bank will top out at a little over 4% before cutting rates next year to stave off a bad recession.
But Fed Chair Jerome Powell may not have that luxury as Dr. Doom reckons achieving a 2% inflation rate without a hard landing will be "mission impossible".
While there are early signs that inflation is easing, economists are divided on how quickly price pressures will ease.
ASX shares to feel the heat
If the Fed were to lift borrowing costs by more than expected, it will put pressure on our RBA to be more hawkish. Our reserve bank may be independent, but as a player in the global economy, relative rates matter more than the RBA cares to admit.
The US stock market is yet to price in 5% interest rates, let alone a long hard recession. This is why investors will be hanging on to Powell's every word tonight.
ASX investors will have a fretful 48 hours though as we have been "blessed" with a public holiday tomorrow.
The earliest we can react to the Fed's decision will be Friday, although Victoria will be on another holiday.
Go Cats!
