The Federal Reserve announced its latest monetary policy decision yesterday afternoon and, as expected, the central bank raised the benchmark short-term interest rate by 0.75%, to the range of 3.00% to 3.25%. Following the disclosure, there was whipsaw action in the U.S. stock market, with equities bouncing back and forth between positive and negative territory before selling off sharply into the closing bell. The more-restrictive stance from the Federal Reserve and hawkish commentary from Chairman Jerome Powell in his ensuing press conference (more below) put downward pressure on stocks in the final hour of trading. The equity futures are indicating a mixed opening stateside today. Earlier today, the Bank of England followed the U.S. move with a half-point increase in its short-term interest rate.
This morning, the economic calendar is light, which will not draw the market’s attention away from the latest Federal Reserve news. At 8:30 A.M. (EDT), the Labor Department reported that initial unemployment claims totaled 213,000 for the week ending September 17th. Continuing claims also came in lower than expected. Those figures were another sign of a tight labor market, which the Federal Reserve noted yesterday in its monetary policy release.
In general, the Fed’s statement contained a number of hawkish comments, including that ongoing rate increases are deemed appropriate. The Federal Open Market Committee (FOMC) also raised the 2022 federal funds target to 4.40%, which was a full percentage point higher than the target at the time of the June meeting. In order to get to that level, it will require a few more aggressive rate increases by year’s end, which was viewed as highly restrictive. Moreover, the central bank said it plans to move forward with reducing its balance sheet by selling fixed-income securities and mortgage-backed assets. This balance sheet maneuvering would remove liquidity from the financial system, and, in time, the Federal Reserve hopes that a reduced money supply would lower demand and push prices down.
Also adding to Wall Street’s consternation was the Chairman doubling down on the hawkish remarks he made at the Jackson Hole, Wyoming meeting in late August. Chairman Powell said the Fed has the “tools and resolve to bring down inflation to the 2.0% range,” but doing that will require a continuation of the highly restrictive monetary policies now in place. He also said that the scope of the rate hikes will depend on several months of pricing data. Before the Fed would consider changing course, it will need to see below-trend economic growth, a better balance of supply and demand in the labor market and signs of inflation easing for several months. In all, the market came away from the press conference with the belief that restoring price stability, while achieving a soft landing for the economy, will be challenging. Hence the drop in the stock prices of many of the economically sensitive equity groups yesterday afternoon, including the industrial, financial, real estate, and materials sectors.
In addition to the inflation fears, the market is simultaneously worried about slowing economic growth, which many economists feel is being hurt by the Fed’s highly restrictive monetary policies. These concerns were backed up by the Federal Reserve lowering its 2022 gross domestic product (GDP) forecast to just +0.2%, versus its previous estimate calling for a 1.7% annual gain. There is also concern that we are now seeing only the effects on output of the early part of this year’s interest-rate tightening phase (since there is a time lag between the Fed’s moves and the impact on the economy), and that three-consecutive three-quarter-point hikes in the federal funds rate (a 2.25% increase in total over just the last three months) will bring more pain to the economy later this year and in 2023. We are already seeing a notable drop in fixed business investment, housing demand, and exports, which is likely to weigh on the nation’s GDP.
But perhaps the biggest stock market impact of slowing economic growth will be through its effects on Corporate America, and we have already seen more pessimism about profits in the coming months. This is not a good backdrop for stocks, as a drop in earnings will likely put more pressure on valuations in addition to the impact of higher interest rates. In this environment of slowing growth and high inflation we continue to recommend that investors look at the stocks of companies that have demonstrated in the past an ability to weather periods of economic downturns. Most of these companies generate steady earnings, ample cash flows and have the capacity to maintain their dividends. Dividends are likely to receive a lot of investor attention, as investors can currently receive a 4% yield on a two-year Treasury note – competition for stocks that don’t pay a meaningful dividend or that may not be able to continue their current dividend levels. Investors should also tread carefully with those companies that do a significant portion of business overseas, as the strength of the U.S. dollar, which hit a 20-year high against a basket of international currencies yesterday afternoon, will adversely impact foreign earnings when translated into dollars.
In all, given the concurrent concerns about inflation and slowing growth, investors are dealing with a very tricky and at times very volatile investment landscape. We note that in turbulent times for the U.S. equity market, those stocks ranked 1 (Highest) or 2 (Above Average) for Safety by Value Line have historically outperformed the broader market averages.
– William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
