It’s easy enough to get into the Fed’s mindset at this point. Another month of hot inflation means Powell and company need to stay on course for one more policy meeting before higher interest rates give us any tangible relief.
That means the tightening probably won’t stop until February, which in turn suggests that overnight rates might climb all the way to 4.5% . . . a full 0.75 point above what even the Fed was willing to contemplate three months ago.
We see this in the rate swaps market and also on the Treasury yield curve, where one-year rates are already flirting with 4% and the middle of the curve (everything between six months and three years) is already well above where the Fed thinks rates will go in the foreseeable future.
Is that forecast even reasonable? Normally the Fed guides expectations to the downside. They’re the bad guys, the party killers. When investors abandon hope to become the ones betting on an aggressive posture, the sentimental relationship has inverted.
And it means the market is doing the Fed’s work for it. By my math, $3 trillion in paper wealth evaporated from the S&P 500 this week, which ultimately reduces liquidity and theoretically cools the economy.
People who feel less rich are more careful with their spending. None of us are as eager to pay more for necessities or even luxuries . . . and we’re more willing to settle for “good enough” wages. We negotiate. We defer gratification.
This makes stocks look cheaper on an absolute basis, don’t get me wrong. As long as earnings remain resilient, this is the kind of dip that will be worth buying. But for now, you need buyers willing to swallow their fears and put money to work.
That’s not happening right now. That’s all right. People with cash can simply park their funds in those same Treasury bonds paying close to 4% a year and lock in that yield. They aren’t doing that either.
I’d be happy to lock in 4% personally. I think stocks like Ford (F) are a long-term buy at this level because that’s the yield their dividends now reflect. And if the Fed itself hasn’t committed to short-term interest rates rising much beyond 2.5% in the long term, that yield is a bargain.
Either way, when fear erases that much liquidity, we do the Fed’s work for it. They won’t need to formally raise interest rates quite so high to get the same inflation-fighting impact.
This week probably represents a full 0.50-0.75 point hike in itself, without changing effective interest rates one bit. In that scenario, rate futures actually need to come down.
But we’ll need to stay cool until at least December to see that happen. Until then, the hawks and the bears are in control. All we can do is get through the next few months and let our longer-term bets ride.
Next month gives Corporate America a chance to confess infinite weakness. If any company feels the need to miss Wall Street’s targets or lower guidance for the future, this is the time.
If that doesn’t happen, rates will probably peak before the next earnings cycle starts up in February. Even the hawks and the bears admit that the Fed starts moving back by March, which isn’t going to happen until inflation recedes or the economy crashes.
Powell is not willing to let the economy crash. He’ll tolerate a slight uptick in unemployment, but we’ve seen him embrace inflation again and again in order to avoid mass layoffs like what we faced in 2007-8.
And if inflation moderates even a little bit between then and now, he’ll flinch. Call it a “pause,” but as long as prices stabilize, the Fed will be happy.
Here’s the thing. Food costs will probably remain elevated on a year-over-year basis through the winter. After that, sticker shock at the supermarket becomes the new normal . . . and because inflation is measured in year-over-year terms, the CPI will go down.
That’s technically a victory. And while heating bills will be bad this winter, similar dynamics apply in the energy market.
We can get through this.