Inflation Continues - 3rd Quarter - 2022
Inflation concerns continued to dominate headlines during the third quarter. The Federal Reserve raised its target interest rate by 0.75% to 3.00% at the end of September, the same level of increase made in July. This is the highest rate since April 2008. Based on the Fed’s latest commentary, markets expect the benchmark lending rate to climb an additional 1.50% by early next year. Rates entered the year at essentially 0% and markets initially priced in an increase to 1% one year out. Rates have clearly exceeded expectations, rising more dramatically than any time in the last forty years. The maxim that one should not “fight the Fed” rang true this year. Virtually all asset prices declined precipitously over the last twelve months as rate hike expectations grew, portending a significant withdrawal of liquidity from the financial system.
It is critical to note there is a six-to-nine-month time lag between policy adjustments and reported economic data. We would therefore not expect to see the effects of the initial rate increases until early next year, and the most recent hikes until mid-2023. We believe the Fed’s efforts to rein in inflation is working and data will support this by the end of the first quarter. Markets will remain volatile until investors anticipate a softening in Fed policy.
The second hurdle for equity markets to contend with is corporate earnings. Third quarter releases will begin this week. Companies’ forward guidance and the language they use to describe it will, in most cases, be much more important than the third quarter financial results themselves. Markets have priced in slowing growth, but some believe we are heading toward a deeper recession than currently predicted. In other words, there is a fear the Fed has tightened too far, too fast. This is an incredibly complex time for the global economy.
A contrarian mindset is required to take advantage of significant pivots in investor sentiment and market movements. Over the past decade, market corrections turned out to be excellent times to buy into risk assets. There are reasons today to be optimistic. The banking system and both consumer and corporate balance sheets are in solid shape. We have yet to witness a material increase in defaults and sentiment, which is nearing 2002 and 2009 levels, is sufficiently bearish.
The key difference or ingredient missing from the recipe today is the highly accommodative monetary policy. Though we expect the Fed’s interest rate hiking to slow and even reverse at some point, we are not anticipating a return to the excessively stimulative policy of the recent past. Investor expectations moving forward, therefore, may need tempering. We are not alluding to a ‘lost decade’ for broad equity performance, but perhaps a moderation back to high, single digits.
Year-end is an important time for tax planning and to reassess goals for the year ahead. We look forward to connecting with you soon.
Thank you for your continued trust and partnership.
EPIQ Partners