Regular readers know Financology doesn’t indulge in the financial media obsession with trying to handicap the number of rate hikes that will occur before a certain arbitrary date on the calendar, what the exact size of the next hike will be or what the effective Fed funds rate will be on any particular date. Investors can find all that’s relevant and knowable about the course of short term interest rates in the Treasury yield curve.
But we stand at an unusual juncture, and it might be amusing if not informative to speculate directly on the next few FOMC policy announcements. As much heathy respect as we have for the wisdom of the bond market, we suspect it might not have everything quite right.
Let’s not call this a forecast … more of a plausible scenario that is at least worth allowing for in our portfolio planning. The Fed hikes 75 bp at its upcoming meeting on September 21. Nothing out of the ordinary about that … it’s what the markets have priced in today. But bear with me … the Fed hikes 75 bp at its upcoming meeting on September 21 … and then … stops. This the market does not have priced in.
What? The next meeting is November 2. The operative hypothesis is that by then, the early signs of victory over inflation will by then have become obvious to all. Oh, YOY CPI won’t have crashed … but the stock market may well have. This would supply all the “tightening of financial conditions” the Fed seeks … and maybe then some. And the proximate trigger for that would be an obvious deterioration in corporate profits due to the lagged effects of higher rates and yields that have already taken place, on top of household budgets already having been painfully stretched by rampant consumer price inflation, finally crushing consumer spending. Details may vary, but the broad strokes are not out of the realm of plausibility. Not to mention that other global issues, from general European collapse due to energy shortages to China collapse due to implosion of its real estate bubble, are all ready and waiting for their place in the headlines. That 2023 could be an ugly year might by then be a hard to deny prospect.
Again this is not a forecast. But even if it doesn’t come to pass, it seems unlikely the Fed will continue to hike at a 75 bp per meeting pace. It has deliberately “front-loaded” policy tightening in an effort to compensate for having fallen so far behind the curve earlier. If, as appears likely, it follows through with a third consecutive 75 bp hike in 13 days, that “front-loading” may well succeed.