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Post: Market Snapshot: Can a bag of groceries weigh down stocks? Wall Street weighs in as the Fed tightens financial conditions

“Last year people paid higher prices, thinking that wasn’t going to last,” says Katie Nixon, CIO for Northern Trust. “Now it is sinking in that prices are going to be higher for a while.”

A shopper at Grand Central Market on March 11, 2022 in downtown Los Angeles as U.S. consumer prices climb to new a 40-year high.

Patrick T. Fallon/Agence France-Presse/Getty Images

Can a bag of groceries weigh down stocks?

That is a key concern as Wall Street watches how American households navigate the heavier burden of higher prices at the grocery store, the gas pump and their credit cards, even though the Federal Reserve has kicked off a series of interest rates hikes to combat inflation.

Read: Two top Fed officials urge more aggressive interest-rates hikes to stifle inflation

“The consumer bailed us out last year,” said Katie Nixon, chief investing officer for Northern Trust Wealth Management, referring to the mix of government financial stimulus and household spending that helped fuel blockbuster corporate earnings and stock-market

returns that topped 26% in 2021.

“Last year people paid higher prices, thinking that wasn’t going to last,” Nixon said, by phone. “Now it is sinking in that prices are going to be higher for a while.”

That is partly because consumers aren’t likely yet seeing the full impact on food prices from Russia’s invasion of Ukraine, she said, or from other commodity prices increases.

See: USDA says Russia’s actions raise uncertainty for agricultural supply, cuts world wheat export estimate

“For the last few years, consumers were able to accommodate their needs and wants,” Nixon said. “The balance of needs and wants is going to get more difficult as we progress through 2022.”

Buyers remorse?

Households in 2021 still had a slug of pandemic fiscal stimulus payments hitting their bank accounts. They also had frequent Fed assurances that two years of easy-money policies weren’t on a collision course with their wallets.

While the tone at the Fed has since changed and tangled supply-chains appear to be easing, consumers from California to Florida already spent much of last year willing to pay near-record prices for big-ticket items, including used cars and homes, often on credit.

Households added about $1 trillion in debt in 2021, the sharpest yearly rise since 2007, increasing their debt total to a record $15.6 trillion, according to the Federal Reserve Bank of New York.

On the plus side, most tapped into credit at a low interest rate in a strong labor market. The worry is it could result in buyer’s remorse or cracks in consumer finances as the Fed steps up efforts to tamp down inflation at 40-year highs by raising interest rates and making credit tighter.

“Consumer balance sheets are in good shape,” said Jake Remley, senior portfolio manager at Income Research + Management. “We probably have a way to go before we see any meaningful stress, absence unexpected shocks.”

At the same time, however, it isn’t hard to imagine higher interest rates coming back to bite for things like used vehicles, where priced in February were fractionally lower, but still up 41.2% over the year.

Check out: How the pandemic turned used cars into hot commodities

“Did we have a bubble in used cars? That is probably question No. 1 as interest rates go up,” Remley said.

Remley also pointed to the more than 40 million borrowers with about $1.6 trillion in combined federal student loans who are expected to have toresume making payments in May, following a more than two-year hiatus without the debt accruing interest.

“That could be a subtle drag on consumer spending,” he said. “That may get extended for a few months. However, it is going to end at some point.”

Home mortgage rates also climbed to about 4% this week for the first time since 2019, presenting another potential headwind to the consumer.

Higher rates, cheaper prices

The Fed on Wednesday raised its benchmark interest rate for the first time since 2018, while signaling policy rates could be near 2% by the end the year, and hover closer to 3% in 2023.

While the first rate increase from near zero won’t have too big an impact on household debt or consumer savings rates, a series of hikes might, particularly if higher costs remain entrenched and slow economic growth and inflation.

Investors responded positively to this week’s quarter percentage point increase in the Fed’s benchmark rate, with the Dow
S&P 500

and Nasdaq Composite

each sweeping to their best week of percentage gains since Nov. 2020. Although with a brutal start to 2022, largely due to the war in Ukraine, the indexes still were lower on the year by 4.4%, 6.4% and 11.2%, respectively.

“The longer inflation potentially lingers at these 40-year record levels,” said Leo Grohowski, chief investment officer at BNY Mellon Wealth Management, “The longer that lingers, that is more harmful to consumers. And that is more harmful to markets than the higher rates engineered by the Fed.”

BNY Mellon pegs the risk of recession — a popular topic of debate lately — at only 20% over the next 12 to 18 months, Grohowski said, even if some consumers who piled into used cars and homes with a “buy first, ask questions later” mentality feel the pinch of higher prices and borrowing rates.

“What the Fed is doing is appropriate, expected, and frankly late,” Grohowski said. “Consumer are going to have to be willing to withstand higher borrowing rates and debt service charges, if they want lower cost of goods at the grocery store and at the gas station.”

Next week will see more Fed officials speak, including Fed Chair Powell on Tuesday. New homes sales data follows on Wednesday, while Thursday brings weekly jobless benefit claims and March manufacturing and services sector data. Friday it is a consumer sentiment reading and inflation expectations, but also pending homes sales.

Related: What happens to money when the Fed starts shrinking its balance sheet?

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