Three challenges to lead to increased market volatility – Morgan Stanley

Volatility continued to roil markets the past week, leading the S&P 500 Index and the technology-heavy Nasdaq Index to their worst week since the onset of the pandemic. But it is unlikely, in the view of strategists at Morgan Stanley, that the markets have now entered calm waters.

A ways to go for rising rates

“The Fed will need to play catch-up on raising rates in an effort to normalize policy. There’s room for the 10-year Treasury yield to rise further. Specifically, we expect it to reach 2.3% by year-end, and this could deliver another 5%-7% hit to equity markets, as rising rates typically lower stock valuations, all else equal.”

A massive balance sheet to wind down

“The Fed has an enormous balance sheet to unwind – and little experience doing so at such a scale. If it does this too quickly, markets could see higher volatility, much like the turbulence that hit investors in December 2018 amid tightening financial conditions and worries that the Fed was moving too fast.”

Geopolitical risks

“Oil prices climbed to their seven-year high last week amid rising tensions around the Russia-Ukraine conflict. Sanctions or military engagements could drive global energy prices higher, further complicating the Fed’s job and consumer expectations. Also, with China now facing down its own Omicron coronavirus wave with another zero-tolerance policy, the potential for renewed global supply-chain disruptions is once again a concern.”