Fed Pivots … From Hawkish To More Hawkish

Fed Pivots … From Hawkish To More Hawkish
Stéphane Renevier, CFA

over 1 year ago3 mins

What just happened?

The Federal Reserve (the Fed) just hiked its key rate by 0.75 percentage points, the fourth-straight move of that size – as was widely expected.

What was not expected was the “hawkish” (meaning in favor of more aggressive hikes) tone of the ensuing press conference, with Chairman Jay Powell twice saying the Fed still has “some ways to go” with its hikes, and saying that the risks of doing too little (i.e. not raising rates high enough to bring down inflation) outweighed the risks of doing too much (i.e. raising rates too high and causing a financial accident, and/or a deep recession).

He said all that while also acknowledging that the path for a “soft landing” (the Goldilocks scenario in which the Fed would hike rates just enough to bring down inflation without a recession) had seriously narrowed.

Put more simply, he clearly admitted that lowering inflation is currently a bigger priority than avoiding a recession.

What does it mean?

It means no dovish bias, no pause, and certainly no pivot. And it means the fed funds rate is now in the 3.75%-4% range.

It also means that investors should focus less on what doesn’t really matter (the number of words in the statement, the hidden meaning of the first sentence, and the color of the chairman’s tie) and focus more on what really matters. And in this case, that’s: how high will rates have to go (he hinted: higher) and how long they’ll need to stay there (he hinted: for longer). Those two questions are even more important than whether the Fed will hike by 0.5 or 0.75 percentage points at its next meeting.

It also means that all eyes are now on the labor market: as long as it remains strong and inflation hot, the Fed will have little choice but to keep hiking.

Why should you care?

The Fed will only pivot when inflation’s showing clear signs of slowing down. The issue is, it’s unlikely that it’ll fall by itself, and the only thing that’s likely to bring it down is a significant (and likely painful) slowdown in the economy.

That’s bad news for most assets, but particularly for stocks. See, while bonds will continue to suffer from high inflation and rising rates, they’ll eventually start to benefit as the economy slows down. For commodities, a slowing economy will eventually hit demand, but as long as supply shortages persist, their prices should remain relatively supported. For stocks, on the other hand, the situation arguably becomes more tricky. That’s because they’ll be hit by the double whammy of rising rates (meaning lower valuations) and slowing growth (meaning falling earnings). This explains the market reaction, with the NASDAQ down more than 3% at the time of writing, crude oil up 1%, and bonds down about 0.3%.

As we keep repeating this year, now is not the time to take on too much risk. That doesn’t mean you have to stay on the sidelines forever though. If you’ve got a long-term horizon, you could see a further selloff as an opportunity to scoop up assets at more attractive prices, and by reducing your entry price, boost your long-term returns.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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