Let it Slow, Let it Slow, Let it Slow
Last December, I wrote a column about the Fed’s final statement of 2021 with a section titled, “Hawk! The Herald Angels Sing,” and it’s remarkable that we sit here one year and 450 basis points in rate hikes later, and I could easily use that title again. It’s also remarkable that the Consumer Price Index (CPI) was at 7.0% last December, and sits at 7.1% today.
It’s almost as if nothing happened. But so much did.
The Federal Open Market Committee (FOMC) raised its policy rate by another 50 basis points (bps) to an upper bound of 4.5%. This was, again, a widely anticipated move, and represents a downshift in the size of hikes from 75 to 50bps. Although a downshift may seem like a good thing, make no mistake that an increase of 50bps is still historically large.
Have Yourself a Scary Little Christmas
There’s no telling what the next couple weeks hold in markets, but it’s safe to say that some of the air has come out of year-end rally balloon. After a ferocious rally from October lows, resistance levels continue to hold on the S&P 500 (as outlined in last week’s column). In other words, we haven’t broken free from this downtrend yet, and we’re not about to, in my opinion.
A big reason I’ve been fairly cautious (ok, negative) over the last few months is that economic data has only just started to weaken, and some parts of the economy (e.g., the labor market) are still sending signals of strength. Economic data is slow to react and is reported on a lag. Monetary policy moves take 6-12 months to flow through and affect economic data. As such, we haven’t seen the full effect — nor even the current effect — that tighter policy has had on the U.S. economy.
Not to mention, Jerome Powell was clear as a bell today that they do not envision cutting rates until 2% inflation is in sight in a sustainable way. No matter the inflation measure you use, we’re still far from 2%.
Some may wonder why we need to focus so relentlessly on inflation, knowing that fighting higher prices is likely to result in lower GDP growth, higher unemployment, and lower corporate profits. Although it’s a fair question, the reality is that an economy cannot sustain high inflation no matter what, and leaving prices high would eventually put us into a recession anyway. Simply put, consumers would eventually run out of savings, businesses wouldn’t be able to cover their costs, and our currency would weaken. The Fed has to fight it, and is fully aware that it will cause pain.
Dot the Halls
We’ve made progress, but this isn’t over ‘til it’s over, and the likelihood of overtightening increases with every hike. That doesn’t mean I think they should stop. In fact, I think this Fed is doing a good job with the task at hand, and I was happy to hear Powell’s steadfast and consistent message.
It’s also important to note that he’s not the only one calling the shots. The dot plot showed 17 of 19 Fed officials believe the fed funds rate will be higher than what the market is pricing in — but the market doesn’t get a vote. There is broad agreement at the Fed about the path they’re on, and we shouldn’t expect that to change without the introduction of materially softer data.
I think the bond market has sniffed this out, the economy is starting to take a whiff, and the stock market is likely to catch wind soon enough. If, and when, we start to see valuations on the S&P that are more appropriate for a restrictive environment, I may finally put the bear to bed and wake up the bull. But until then, I’m holding steady in cautious town. Happy holidays to all and thank you for reading my musings this year.
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