The Fed’s largest rate increase since 1994

Last Wednesday the Fed increased the federal funds rate by .75% (the largest increase since 1994) and signaled additional aggressive rate increases will follow in an attempt to subdue inflation. Further, Chairman Powell acknowledged that such aggressive actions will make it more difficult to achieve an economic soft-landing¹.

Is recession inevitable? Not necessarily, but surely the odds are increasing.

With regular unleaded gasoline prices at historic highs of just over $5.00 per gallon² and grocery prices up over 11.9% from last year³, inflation is starting to negatively impact consumer spending patterns. U.S. retail sales in May fell 0.3% from April, the first monthly decline in 2022, as consumers cut back on auto, furniture, and general spending in order to fund gas and food spending⁴. Major retailers, most recently Target, are also warning of changing consumer spending patterns away from discretionary items.

And although the Fed is only in the early stages of fed funds rate hikes, interest rates are already spiking across the economy and impacting growth. A 30-year fixed rate mortgage is now 5.91% versus 3.27% on December 31, 2021⁵. As a result, mortgage applications for home purchases have plummeted approximately 20% from last year⁶ and the number of existing home sales are at their lowest level in almost two years⁷.

But there are still some reasons to hold out hope for a soft-landing, or at least avoiding a deep recession. There still seems to be some pent-up consumer demand for both goods and services, the labor market remains relatively robust with solid employment growth and income gains, corporate balances sheets are strong, and the banking system is well capitalized.

It is probably important to keep in mind that the upcoming expected slowdown in economic growth is more about supply scarcity, inflation, and Fed policy rather than a lack of demand. And while still an unpleasant experience, such a recessionary scenario seems a bit more benign than scenarios that include a complete shutdown of the global economy (our last recession in 2020) or the potential collapse of the banking system (2008-2009 recession). Recessions are an inevitable part of our economic cycles, and we seem to find our way through – even those recessions caused by the most ominous of circumstances.

As mentioned is our last market update, we expect volatility in the financial markets to stay elevated in the near-term. The Fed is still early in its quantitative tightening path, and we expect economic and corporate earnings releases in the coming months to contain a mixture of positive and negative results reflecting the impacts of Fed policy and a slowing economy. We also expect corporate earnings estimates to begin to fall reflecting the expected slowdown in economic growth, which along with high inflation and increasing interest rates may negatively impact stock valuations and prices. As such, we continue to have a cautious view on the economy and financial markets. Evidence of a deceleration in inflation would surely provide a basis for a more constructive viewpoint.

In the meantime, we advise clients to assess and plan for near-term liquidity needs, but remain focused on long-term investment goals and objectives. Please reach out to your investment team should you have any concerns regarding the financial markets, economy, or your portfolio. An assessment of your portfolio’s asset allocation in relation to your investment objectives and planning for near-term liquidity needs are always a beneficial exercise.