Aggressive Fed sends interest rates higher
Rising interest rates and softer equities were the major themes in September as markets continued to digest an aggressive Federal Reserve.
Elevated inflation continues to persist, with the most recent Personal Consumption Expenditures (PCE) Index data showing consumer inflation taking a 4.9% jump[iv] in August from a year earlier versus expectations of 4.7%. The August Core Consumer Price Index (CPI) was also running hotter than expected.
The higher CPI and PCE keep the Federal Reserve’s door open for further hikes. It seems that the benchmark overnight Fed Funds rate increasing from 0.25% to 3.25% has not had the desired impact on inflation–at least not yet.
We will get our next peek at the widely followed CPI metric for September on Thursday, October 13th.
Government Bond Yields Rise
As interest rates rise, bond prices typically decline, resulting in higher bond yields. As such, the recent surge in interest rates can create opportunities for certain investors seeking higher fixed-income yields.
That said, while interest rates–and subsequently bond yields–have risen steadily, we do need to keep in mind that rates have been much higher in the distant past. Let’s not forget that 30-year mortgage rates exceeded 17%[vii] in 1981 and 1982. Yet we do recognize that the past does little to comfort those who are currently trying to buy a home for the first time. If you are considering buying a home, take a few minutes to read this blog post.
Continuing the downtrend beginning in June, crude oil prices traded lower in September, with the November futures contract closing under $80. This marked the first front-month contract monthly close under $80 since December[viii].
The decline in crude has translated to lower gas pricing in most U.S. markets with some easing for consumers at the pump. The national average price[x] per gallon was $3.799 (regular) and $4.575 (premium) as Americans began their daily commute on October 3, the first workday of the month.
The Fed raised rates by 75 basis points[xi] in the September meeting, bringing the current target rate to 3.00% – 3.25%. As we have witnessed this rapid rise in the overnight lending rate, some have speculated that the Fed is overtightening[xii].
It seems that the Fed may be opting for a hard landing[xiii]: getting the rate hikes done swiftly and aggressively in hopes the resulting fallout is short-lived. In contrast, a soft-landing[xiv] approach would most likely have been to raise slowly and without tipping the U.S. into recession.
Many indicators show that the United States is already in a recession (and has been for some time). Of course, the definition of a “recession” is still up for debate. Most people aren’t getting hung up on terminology but instead would like to know how long it’s going to last.
Unemployment increased, resting at 3.7% vs. 3.6% expected. Expectations[xvi] are for further increases in the unemployment rate as the Fed continues its rate hike campaign.
We’ll get the latest economic data on employment during the first week of October.
Reduced Earnings Expectations
Third-quarter earnings season will be in mid-October. As of September 30th, analysts had reduced their expectations by 6.6% versus their forecasts from three months ago, according to data from Factset[xvii].
Through September 30th, 15 of the 500 S&P 500 companies have reported. Results are 8.3% lower versus one year ago, while revenues are higher (+10.5%). In addition, 66.7% of the companies beat earnings per share (EPS) estimates and 53.3% beat revenue estimates.
The expected culprits are supply chain issues, inflation, and the stronger dollar.
September featured a tone of volatility over the Fed’s outlook and expectations for further rate hikes ahead. Inflation metrics remain elevated, and the Fed seems to be on a hard-landing mission to quell inflation.
While the environment is challenging, this current cycle had to play out sooner or later, as monetary policy is variable. Easy monetary policy can’t remain easy forever, and tight monetary policy won’t remain tight forever.
Long-term investors will experience multiple cycles of expansion and contraction over a lifetime. Depending on their goals, there may be alternative opportunities in fixed-income, while for others, simply continuing along with current strategies may be suitable. Remember to think long-term, history is on the side of the investors.
If you need us, we are here.
[iv] Cox, J. (2022, September 30). Cnbc.com. Fed’s preferred gauge shows inflation accelerated even more than expected in August. [Online] Available at: PCE inflation August 2022: Inflation accelerated even more than expected in August (cnbc.com)
[vii] (2022, September 29). Stlouisfed.org. 30-Year Fixed Rate Mortgage Average in the United States. [Online] Available at: 30-Year Fixed Rate Mortgage Average in the United States (MORTGAGE30US) | FRED | St. Louis Fed (stlouisfed.org)
[xi] (2022, September 21). Investopedia.com. Fed Raises Rates by 75 Basis Points at September 2022 Meeting. [Online] Available at: Fed Raises Rates by 75 Basis Points at September 2022 Meeting (investopedia.com)
[xii] Sonnenfeld, J. and Tian, S. (2022, September 28). Fortune.com. The Fed is oversteering on inflation – every signal suggests it’s already cooling. [Online] Available at: The Fed is oversteering on inflation–every signal suggests it’s already cooling | Fortune
[xiii] Sor, J. (2022, September 14). Marketsbusinessinsider.com. Markets are starting to acknowledge the Fed is on track for a hard landing, Nomura strategist says. [Online] Available at: Markets Are Acknowledging the Fed Is on Track for a Hard Landing: Nomura (businessinsider.com)
[xiv] Goodkind, N. (2022, September 26). Cnn.com. Forget a soft landing. The market’s best hope is a ‘growth’ recession. [Online] Available at: Forget a soft landing. The market’s best hope is a “growth” recession | CNN Business
[xvi] Ivanova, I. (2022, September 30). Cbsnews.com. Buckle up, America: The Fed plans to sharply boost unemployment. [Online] Available at: Buckle up, America: The Fed plans to sharply boost unemployment – CBS News
[xvii] Butters, J. (2022, September 30). Insight.factset.com. Largest Cuts to EPS Estimates for S&P 500 Companies for Q3 2022 in More Than Two Years. [Online] Available at: Largest Cuts to EPS Estimates for S&P 500 Companies for Q3 2022 in More Than Two Years (factset.com)
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