The Federal Reserve raised its overnight rate by 0.75% yesterday. This was anticipated by the market, but a significant change from their prior meeting, where Jerome Powell said that hikes would likely be 0.5% per meeting and a three-quarter point hike was not actively discussed. Elevated inflationary data seems to have forced the Fed’s hand. The collective wisdom is that the Fed is behind the curve and is now trying to catch up to where the market already is. The initial reaction was positive, as the market seemed to get what it wanted. But a day later the markets woke up to the realization that higher rates are not generally good for risk assets.
One positive that came from the meeting is that the Fed and the broader market now seem to be on the same page about where rates need to go to tame inflation. Current estimates are for the Fed’s terminal rate to be around 3.8% That would generally coincide with the 10-Year Treasury yield peaking at about 3.75%. While nobody knows where rates will ultimately go, having a relatively agreed upon path gives market participants something to coalesce around.
The “R” word is starting to be brought up more frequently. Recessions are defined in hindsight, but our belief that avoiding a recession at this point is unlikely. We think that a recession may be needed to tamp down inflationary concerns, as well as clear speculative froth that has formed over the last few years. Recessions can be difficult, but they are also a necessary part of economic cycles and pave the way for future growth in the economy. Our clients know we are not in the business of predicting stock market moves. With that caveat, 75 years of historical precedent indicate that equity markets bottom prior to midterm elections. It would not be a surprise to see markets find their footing by the fourth quarter of this year.
The Federal Reserve has a difficult and thankless job. They are generally in a position of fighting yesterday’s battles. Our sense is that is the case this time as well. While inflation is a clear and present danger, declines in the stock and bond markets, along with what could be a materially slowing housing market should be deflationary. While the war in Ukraine may continue to keep food and energy prices elevated, slowing economic activity will likely weigh on pricing in other areas.
As you know, we have heavily weighted the sell side of the ledger in our investment portfolios. We took meaningful gains in both 2021 and 2022 and have a very high degree of liquidity. The bulk of our purchases this year continue to be in short-term Treasuries. At this point, many stocks look to be discounting a slowdown, if not a recession. If we are in fact in a recession, there is probably some additional discounting that needs to be done. However, we are now at a point where opportunistic buying makes more sense than it has in the last few years. Thank you for allowing us to be your private wealth management team.