The Fed: One and Done?
It would seem so. That’s the prevailing view among analysts and investors following last week’s parting shot from the FOMC in the form of a .25bp hike in the Fed Funds rate. For many, it felt like the door hitting our backside as we neared the exit of the Fed’s credit-tightened, financial ecosystem. Whether this move was necessary to win the inflation battle was hotly debated prior to Wednesday’s announcement. With that increase pushing the key rate to 5.25%, the debate now shifts to whether the Fed has all but assured the onset of a recession in the year ahead. Those looking back to the days of Paul Volcker subscribe to that view while questioning only its depth and severity. Continued full employment, however, gives others pause. While loosening their grip on the idea of a soft landing, they build a strong case for a shallow recession at worst, one that the market has already priced in.
We’re among those who believe the stage is set for a pause in additional rate increases coming out of the June 13 Fed meeting. The Fed chairman’s statement following the prior meeting hinted of the board’s willingness to await data expected to confirm a continued decline of inflation. He was careful to mention that the mandated 2% rate was still the ultimate goal. We’ll have to get used to that for some time as last week’s 4.9% annual increase in prices leaves a lot of room, and time, for improvement. We suspect progress toward the goal line will be slow and uneven if the process continues without a softening of employment. The Fed may get an unexpected assist from lingering concerns surrounding several mismanaged regional banks and the potential risk of contagion to the broader economy. We see that as all the more reason to take a breather and assess whether other banks will run afoul of standards and the effects on lending practices. It’s possible that credit will be tightened by the larger banks, adding to the Fed’s efforts to slow investment and achieve below-trend growth.
Meanwhile, all eyes remain on economic data and earnings. For the former, bad results are good news for Fed-watchers as it increases the likelihood of the FOMC easing off the brakes and moving the economy a step closer to the day when the next expansion begins. We expect weaker industrial/manufacturing activity, stagnant consumption, and declining housing prices will continue to confirm progress toward the Fed’s goal of regaining longer-term price stability.
As for earnings, bad news is actually just that. It’s often a harbinger of a recession and a measure of its severity. Currently, we’re seeing the Fed score points against inflation at a cost to earnings and stock prices. As you might expect with aggressive tightening by the Fed in 2022, S&P 500 earnings declined roughly 18% from that of a record high in 2021. Investors took note. As we near the end of the Fed’s current policy cycle, current estimates for 2023 call for low to middle-single-digit earnings growth at best.
In truth, the remainder of ’23 remains a tossup with regard to earnings and explains the stock market’s retreat into an even tighter trading range with shifting divergences among sectors and indexes. Notably, even the short-term trading crowd has been unable to launch a meaningful breakout in either direction. It’s indicative of a high level of uncertainty balanced evenly between investors who anticipate a breakout, either up or down, from that trading range. More the reason now to maintain diversification and be attentive to liquidity levels in portfolios. Stay tuned.
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