Hot Hike Summer
It’s hard to believe we’re only four hikes and just over four months into this hiking cycle. Yesterday, the Federal Open Market Committee raised its target policy rate by another 75 basis points to an upper bound of 2.50%. It was a widely anticipated move. As usual, the real news was in Chairman Powell’s comments after the announcement as markets tried to decipher what the path forward looks like.
The stock market liked what it heard. I think the right thing to do is to continue focusing on inflation as the main enemy, but the reaction in both the S&P 500 and the Nasdaq struck me as outsized positive moves given the Fed’s clear commitment to hiking further. I won’t be surprised if we give some of it back in the next couple days — after all, markets do tend to overreact in the short-term.
However, I do think this is the last 75 basis point move we see out of the Fed, and markets may be readying for a more gentle hiking cycle into the fall.
Despite increasing fears of recession and many wondering whether a recession would slow the Fed down, Jerome Powell reiterated that they still have the tools and the resolve to bring prices down. He even pointed out that the tightening in financial conditions driven by the Fed hikes is likely to include below-trend economic growth and some softening in labor market conditions.
What I heard was, regardless of the collateral damage that could result from rate hikes, it won’t stop the Fed from charging forward.
Good. It shouldn’t, in my opinion. The whole goal of this process is to create slack in the economy that alleviates the upward pressure on prices. Slack leads to less demand, which leads to cooler inflation.
This is Tackle, not Touch
I also heard in his comments that there’s a bigger risk in doing too little, than in doing too much. Fighting inflation is a full contact sport and the level of slowdown that needs to happen in order to get it back in check is a level that will inevitably be felt by everyone.
The main question that remains is whether a deep and painful recession will result. My take at present is that inflation will cool in coming months enough to satisfy the stock market and allow it to find some upside. Economic and earnings data is also likely to show further signs of slowing, which could give the Fed clearance to reduce the size of hikes come September. Another “positive” for the market in the near-term.
What keeps me up at night is the possibility that inflation stays with us into 2023 and causes a recession that brings with it job losses and demand destruction for some time. The 2s/10s spread alone now clearly signals a recession could hit us in the next 6-18 months. Until we know more about that possibility though, I think investors may enjoy a market that grinds higher from here to the end of the year.
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