July 2022 – By Kyle Rohrwasser
In last month’s memo, I quoted Jerome Powell; he stated in May that the Federal Reserve (Fed) would not raise the federal funds rate higher than 50 basis points in June, but they moved it to 75 basis points after a higher-than-expected inflation number. This time around a 75-basis point rate hike is locked in but a 100 (1%) basis point move is still on the table.
Current rate probabilities for July’s rate hike are a 78% chance of a 75-basis point hike and a 22% chance of a 100-basis point hike. This reminds us of the last year where the Federal Reserve has continued to drift higher and push rates more than expected due to continuing inflationary pressure. The most recent inflation report being hotter than expected had these percentages all over the place. Putting the chance of a 1% rate hike at over 80% probability before Fed Governors calmed that news down.
If the Federal Reserve sticks to their guns and move the federal funds rate 75 basis points it would put the new range at 225-250 (2.25% – 2.50%) and with the 2-year treasury sitting at 3.10% as I write this, the Fed has only one more rate hike of this amount to match where the fixed income market has traded to. They have room to move but as we come to September, we will get a clearer picture of how much more the market may have to price in. We are looking for some good news over the next few months which will give reason for the Fed to slow down rate hikes and eventually stop. Markets are forward looking so any good news on inflation, China, Ukraine, or oil would be welcome news toward better economic times.
The 2-year and 10-year treasuries have inverted meaning there is a better yield from the 2-year bond vs a 10-year bond. In most cases this leads to a recession and with first quarter GDP growth being negative, we get the sense that we are already there. Though this recession would be much different than those of the past as the employment numbers have been very strong with the unemployment rate staying steady at 3.6% for the last 4 months. In past recessionary environments we have seen substantially higher unemployment numbers so it may lead to a quicker economic recovery if strong employment continues.
Although this news may be uninspiring, we challenge you to look back in history through other adverse economic times. Looking back at the last 11 recessions, the market was positive five times during the recessionary period and finished with a positive return one year after the recession 10 times. On average, stocks perform worse 1 year before a recession than they do during a recession. In the two years following a recession, price returns were positive 82% of the time. This is a gentle reminder to not let a year of returns dictate investment decisions for the many years to come.
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