You Don’t Have to Go Home, But You Can’t Stay Here
Say what you will about the Federal Reserve, but Chairman Jerome Powell has thrown one heck of a party in the two-plus years since the Covid pandemic began. Since the last financial crisis in 2008, the Fed has been no stranger to spiking the punch bowl in the form of quantitative easing and keeping rates near zero. But the 2020 response dwarfed all efforts that came before it. The Fed doubled their balance sheet from $4 trillion to $8 trillion, purchased corporate bonds for the first time, lent out $800 billion in PPP loans and kept rates ultra-low long after inflation began flashing red warning signs.
Since inflation began to rise and the high-flyers of the Covid rally began breaking down under the surface of the equity indices in mid-2021, we have been warning about last call. Now, midway through 2022, the Fed has removed the punchbowl, shut off the music and turned up the lights. Rate hikes have accelerated from 25 bp earlier in the year to 75 or 100 bp expected at upcoming meetings. Quantitative tightening has begun at a faster pace than ever attempted previously. The party is over, and markets must now deal with the hangover.
We’ve all been hearing the word “unprecedented” a lot in the last two and a half years. First there was the unprecedented global spread of a novel coronavirus, then unprecedented lockdowns followed by unprecedented stimulus from central banks and governments. The economic shocks resulting from the actions taken back in 2020 have put the economy into truly uncharted waters today and have forced the Federal Reserve to walk a tightrope balancing inflation and growth concerns simultaneously.
For the first two months of the quarter, the market narrative was that inflation had peaked after falling from 8.5% in March to 8.3% in April.
The stock and bond markets stabilized as traders priced in a more dovish Fed. Hopes of an inflation peak were dashed in May when CPI rose again to a new cycle high of 8.6%, followed by another unexpectedly high reading of 9.1% in June. Combined with a University of Michigan survey showing consumer expectations of inflation had risen more than expected, the market abruptly began pricing in more aggressive rate hikes and risk assets resumed their downward trend. When the Fed met for its June meeting, Chairman Jerome Powell did not disappoint. He delivered a 75 bp rate hike and indicated another move of that scale was likely at this week’s Federal Reserve meeting on Wednesday.
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