On October 27, Q3, GDP came in higher than expected, with a 2.6% gain. After declines in Q1 and Q2, the US economy grew in Q3. While two consecutive quarterly GDP declines are the textbook definition of a recession, the third quarter results were a ray of sunshine for the administration as voters head to the polls for the midterm elections this week. Polls show that Democrats could lose control of the House of Representatives and the Senate, but many contests are neck and neck.
While economic growth is flat over the first nine months of 2022, the latest GDP data provided the FOMC with clear sailing for the fourth consecutive 75 basis point rate hike at last week’s meeting.
On November 2, the Fed did not disappoint as it pushed the short-term Fed Funds Rate to a range between 3.75% and 4.00%. A knee-jerk bullish reaction gave way to selling in markets across all asset classes as the Fed’s Chairman gave an extremely hawkish press conference. Friday’s better-than-expected jobs data did little to deter the Fed at the upcoming December FOMC meeting.
The Fed hike included language that caused a momentary bullish response
- The rate hike was expected and unanimous.
- The Fed’s statement said, “Monetary policy needs to be sufficiently restrictive to return inflation to its target.”
- The statement acknowledged the “lag” between rate increases and economic data- A change from the previous meetings.
- Acknowledging the “lag” caused a momentary knee-jerk bullish reaction.
The press conference was another story- Markets quickly reversed
- Fed Chairman Jerome Powell quickly burst any hopes for a dovish interpretation.
- The Chairman was the hawk in chief, saying ongoing rate hikes are appropriate.
- Buying ran out of steam, with the NASDAQ finishing Thursday down over 3% and the S&P 500 falling 2.5%.
- The dollar rallied, and bonds and commodities turned lower as the Chairman continued the hawkish squawking.
- Markets followed through on the downside on Thursday, but Friday was a different story. Stocks and commodities rallied, while bonds and the dollar index declined.
Higher rates increase the odds of a recession for at least three reasons
- Reason one- Thirty-year fixed-rate conventional mortgage rates have increased from under 3% in late 2021 to over 7% in November 2022. The monthly payment on a $300,000 mortgage is around $1,000 higher, weighing on the housing market. Housing is the most significant asset held by most people.
- Reason two- The rising Fed Funds rate is pushing car loans, credit cards, and other financing rates to the highest level in years. The trajectory of rate hikes will cause a significant economic slowdown as consumers reduce or stop spending.
- Reason three- Interest rates are the primary factor for the path of least resistance of currency values. The latest rate hike supports the bullish trend in the US dollar against other world foreign exchange instruments that have pushed the US currency to the highest level in two decades. A rising dollar makes US multinational companies less competitive globally, weighing on earnings.
Supply-side economic factors are critical and beyond the Fed’s reach
- The Fed’s commitment to pushing inflation to its 2% target rate depends on the success of monetary policy’s impact on the economy’s demand side.
- Higher food and energy prices are a function of the turmoil in the geopolitical landscape that impacts the prices for all goods and services.
- Hawkish monetary policy may not have the desired effect if the war in Ukraine and tensions between the nuclear powers continue to rise.
- Easing of Chinese COVID-19 restrictions could cause commodities to explode, as we witnessed Friday. Copper a bellwether metal rallied 25.95 cents, crude oil was $4.44 per barrel higher, and gold moved over $45 higher on November 4, in a sign that inflation continues to rage.
The US central bank’s critical takeaways
- The Fed is not backing down- More rate hikes are on the horizon.
- The central bank is willing to trade a recession for lower inflation.
- A 5% handle on the Fed Funds Rate is now a virtual certainty in early 2023.
- The Fed has dug in its heels on a reactive instead of a proactive approach to monetary policy.
- Data will determine the course over the coming months.
- If supply-side factors prevent inflation from falling, the Fed could face some real challenges.
- Expect volatility, and you will not be disappointed!
Thanks for reading, and stay tuned for the next edition of the Tradier Rundown!