|Anticipation of a “Fed Pivot” drove the most recent bear market rally. From June through mid-August, the S&P 500 rose nearly 19% because stock investors began to think the Federal Reserve would end its rate-hike cycle earlier than originally anticipated. Broad commodity indexes fell over 20% during the summer, a hopeful sign of lower inflation to come. However, Fed officials have continued to stress that inflation is too high and that they are willing to inflict a degree of pain on the economy and financial markets to get it under control. Last week’s inflation report only served to embolden the Fed, as inflation increased faster paced than projected. Markets now expect a 0.75% increase in the Federal Funds Rate at their September 21, 2022, meeting.|
We believe this means more volatility for the stock market. Given the level of interest rates, tighter Fed policy to come, and the likely future path of leading economic indicators, we expect lower earnings and valuations as we move toward year-end.
If stocks require a friendlier Fed to sustainably move back to old highs, what might we need to see for that to become a reality? For now, we do not appear close to ticking any of these boxes.
- Several month-on-month (MoM) inflation numbers annualizing to less than 3%: currently, MoM headline CPI is annualizing to 5.6% and MoM core CPI is annualizing to 6.4%.1
- Lower inflation expectations: although improved from earlier in the year, long-term inflation expectations are too high – still exceeding 3%.2
- A weaker labor market: wages are the labor market metric most directly tied to inflation. Measures of wage growth, such as average hourly earnings and the Atlanta Fed’s wage tracker, remain much higher than in the period in recent memory. In our opinion, the Fed will not feel comfortable until wage growth settles at lower levels.
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