The Federal Reserve raised rates .75% this week, a historically very significant increase (after increasing .75 last month). The stock market has rebounded of late on the expectation that inflation has peaked due to the sharp drop of gas prices in July and a grain export deal in Ukraine. While that is definitely a positive, we still have an economy that is just starting to grapple with the one of the steepest interest rate increases in modern history. While we are far from out of the woods, there are some signs that perhaps it is now getting lighter instead of darker. See additional commentary below from our research team.
Devon Porpora, Senior Managing Director, Wealth Manager
First Republic Investment Management
What’s Important
- The Federal Open Market Committee (FOMC) increased the fed funds rate by an expected 75 basis points (bps) for a second consecutive meeting. With inflation significantly above the Federal Reserve (the Fed) threshold, the policy statement maintained a hawkish tone as officials reiterated their drive to return inflation to its 2% objective.
- The FOMC’s assessment of current macroeconomic conditions acknowledged the recent softening in consumer spending and production activity but highlighted the strength of the labor market as job gains remain “robust” and the unemployment rate low. The FOMC’s view on inflation was unchanged due to supply chain disruptions, higher food and energy prices, and broadening price pressures.
- Fed guidance on the future path of tightening was unchanged, noting that ongoing rate increases will remain appropriate. We’d expect that future rate hikes would be more modest.
Fixed Income
- Fixed income markets began the morning with gains, following the same pattern of market strength over the past week. Following the Fed’s actions and press conference, short-term U.S. Treasury yields remained generally lower, but longer maturities rose, ending the day with a steeper yield curve. Corporate credit spreads and municipal sectors were largely unchanged.
- Our fixed income positioning remains short duration, a barbelled yield curve positioning and higher credit quality.
Equities
- In our view, the equity rally over the past few weeks has jumped the curve too soon. Fed officials have been steadfast in their commitment to battling inflation and given little indication of wanting to deviate from their explicit and implicit policy paths.
- With leading segments of the economy, such as housing and manufacturing, already under pressure, we’d expect weaker growth to continue and begin biting into corporate profitability. Corporate management has recently begun to manage earnings expectations lower for upcoming periods, and analyst downgrades are outnumbering upgrades by about 3:1 for this year and next.
- We remain defensive in our positioning as we view greater risks to corporate earnings as growth slows, and we’d use periods of strength as an opportunity to reduce overexposed risk positions. Ultimately, we’d consider becoming more constructive on equities when profit expectations move lower and a policy shift is more concrete.
