Asset Management
07/31/2023 Market Strategy
July 31, 2023
To Hike or Not to Hike Remains the Question
The central issue persists as inflation is falling but remains well above the Fed’s target
Key Takeaways
- With a little more than half of the companies of the S&P 500 having reported Q2 earnings, the results are shaping up to be stronger than expected. Earnings are up 3.6% YoY, a much stronger result than the -6.4% contraction expected at the start of the season.
- The Federal Reserve’s rate hike last week was well digested by the equity market. Bond prices in the Treasury market moved lower, sending rates higher, acknowledging that the Fed may have more tightening to do to bring inflation in line with its target.
- Fed policy has been successful to the degree that predictions of imminent recession appear to be receding among pundits.
- Last week’s consumer confidence reports showed a second sharp rise as consumers see inflation coming down.
The Federal Reserve raised its benchmark rate last week as expected by 0.25% with the band range for the Fed Funds rate now standing at 5.25% to 5.5%. The Fed has increased its benchmark rate 11 times since March 2022 with just one pause in the current rate hike cycle when it met in June taking the rate from a rate band of 0% to 0.25% established at the height of the pandemic crisis in mid-March of 2020 to the aforementioned current levels.
The headline CPI inflation rate has recently dropped to 3% in June—nearly to the Fed’s rate target of 2% while core CPI (ex-energy and food) remained elevated at 4.8%. The months ahead will ultimately be the judge of how much more the Fed may have to remain highly vigilant against inflation. With the direction of energy prices in flux and food items still pricey for many supermarket shoppers along with elevated housing rental costs these issues remain key obstacles to bringing the inflation rate still lower.
In our view the Fed has made considerable progress against inflation from being behind the curve when it pivoted in 2022 and moved away from a policy established amid a pandemic crisis which when mixed with political largesse (via the fiscal policies of two administrations) led to what we and others have called a period of “free money” and inflation at 40-year highs
While the proverbial risk of the Fed “breaking something” in the process of a rate tightening cycle has been averted the risk remains on the landscape so long as the Fed’s target remains out of reach.
There is some speculation among investors and Fed watchers that the Fed will eventually have to relent should inflation get stuck on either or both headline and core levels not quite at the central bank’s target rate. We believe the Federal Reserve is serious about curbing untoward levels of inflation and that Chairman Jerome Powell doesn’t want to risk inflation getting out of hand as it did in the 1970s that required draconian measures by then-Fed Chair Paul Volcker who inherited inflation that had become deeply embedded in the US economy over a long period of time as a result of ineffective policy implemented by Volcker’s predecessor.
An end of “free money” by the current Fed in our view re-establishes a traditional relationship between borrowers and lenders wherein bond issuers (for example) pay for the privilege of borrowing money and bond buyers get something in return for the money they effectively lend an issuer when buying a bond.
Based on the relative strength and resilience the US economy currently shows the effect of “an end to free money” should be good for investors seeking improved fundamentals but not so good for high leveraged bets. We expect the cost of carry will separate the wheat from the chaff in the months ahead.
“Free money” or money lent at the historic rate lows seen during the pandemic led to speculation in crypto currencies, meme stocks, real estate and a broad array of other assets.
For now Fed policy has been successful to a degree and predictions of recession appear to be receding among talking heads if not quite at the pace that equity bears have capitulated over the course of the past few months.
From our perch on the market radar screen it looks like the success the Fed has had so far in hiking rates as aggressively as it has can be attributed not only to its own efforts but to resilience reflected in a wide range of businesses, among consumers, and in job growth. The economy has slowed some but not to the extent that many had expected.
While the proverbial risk of the Fed “breaking something” in the process of a rate tightening cycle has been averted the risk remains on the landscape so long as the Fed’s target remains out of reach and it continues to hike rates. That said, the Federal Reserve has shown sensitivity as to how its efforts to curb inflation could hurt the economy. The transparency and level of communications it has maintained suggest it just might avert a hard landing this cycle.
Name:
John Stoltzfus
Title:Chief Investment Strategist, Oppenheimer Asset Management Inc.
John is one of the most popular faces around Oppenheimer: our clients have come to rely on his market recaps for timely analysis and a confident viewpoint on the road forward. He frequently lends his expertise to CNBC, Bloomberg, Fox Business, and other notable networks.
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