The Fed said it intends to raise its Fed Funds rate another 1.25% before the end of 2022. What impact do we expect this will have on the U.S. economy and financial markets?
- The Fed’s goal is to bring down inflation by reducing “aggregate demand” (spending by consumers, business, government and foreign buyers of U.S. goods). This means slowing economic growth and reducing the gap between job vacancies and unemployed persons.
- Economic growth and spending updates last week still indicate negative GDP growth in the first half of 2022 but positive GDP growth in 2022-Q3. September job growth is also expected to be +250,000 after 315,000 new jobs added in August. The unemployment rate most likely will remain at 3.7%.
- The 10-year Treasury interest rate closed last Friday at 3.8% vs. 3.3% for the 3-month Treasury Bills, meaning the yield curve is still positive and a U.S. recession likely is not imminent even with slowing economic growth.
Higher U.S. interest rates are punishing U.S. stock prices, along with fears that a U.S. economic recession will also create an earnings recession. Historically, stock markets can perform well during rising interest rates cycles, but we are watching for signs of further trouble for equity prices.
- Higher interest rates have a negative effect on the value of future earnings and make fixed income investments a more attractive investment alternative. Over the past 60 years, however, the correlation between the 10-year Treasury yield and the S&P 500 index is “0”, not negative. Even when the Fed Funds rate is rising, stock prices have risen too.
- So, we are watching corporate earnings to see if they can continue to grow from consumer spending that is drawing on the excess savings built up during the pandemic stimulus programs.
- Meanwhile, risk asset prices are especially low with negative market sentiment as we head into a U.S. mid-term election whose results are totally up for grabs at this point, hence higher negative volatility.
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