Recap of the Fed’s Announcement

Yesterday’s Federal Reserve announcement initially provided some hope for investors. As expected, the committee raised its short-term policy interest rate by .75%, bringing the rate up to 4.0%. In addition, it modified the accompanying statement to say that when making future policy decisions, the Fed will consider the cumulative impact of this year’s rate hikes, as well as the historical lag between policy action and its impact on the economy. In other words, they understand some patience is called for in the fight to quell inflation. They’re signaling a change of pace. From March until now, the Fed’s goal was to quickly get to a “sufficiently restrictive” level of rates to ensure high inflation wouldn’t become entrenched like it did in the late ‘70s and early ‘80s. We don’t know exactly what that level is, but once there—and we’re very close—the Fed will slow or pause rate hikes and allow time to do the rest. This common sense approach is what we wanted to hear from them.

Next came Fed Chair Powell’s press conference, in which he implied that the pace of rate hikes could slow after next month’s policy meeting. So far, so good. He also acknowledged that the government’s primary way of calculating inflation is flawed, and that the Fed looks at a much more broad range of data to get at what’s really happening on the ground. That’s comforting.

Unfortunately, he also said that the Fed’s stopping point on interest rates is probably higher than they previously expected. He didn’t give any numbers, but bond market trading predicts a Fed-funds rate just over 5% by next May. In other words, we’ve still got another 1% of rate hikes to come within the next several months. Why is the so-called “terminal rate” higher than expected? Well, he explained, the labor market has been far stronger than expected (or “overheated” as he called it). How is he supposed to bring down inflation when jobs are so plentiful and wages are rising at 5%?

And it is true that despite all the talk of recession fear, consumers and businesses continue to spend like everything is OK. On his CNBC show Mad Money, Jim Cramer addressed the consumer side. “You’d think people would be trading down to cheaper brands.” But according to Clorox and Estee Lauder, they’re not. Also, airline seats are full. Visa and American Express reported very strong travel demand. And Disney’s theme parks are doing very well, thank you. He says, “historically speaking, none of this should be happening” while the Fed is aggressively tightening monetary policy to contain inflation.

In the aftermath of the presser yesterday, stocks & bond prices fell across the board, and the dollar strengthened. And this morning the same trend followed through at the open. Bloomberg ran an article titled, “Deeper US Recession Looms as Resilient Labor Market Spurs Fed.” But I think this is a bit overdone, and I’ll tell you why. First, the Fed is now signaling its willingness to be patient. It’s own forecasts say it will take three years for inflation to drop to its long-run target of 2%. Second, investors’ expectation for the Fed-funds terminal rate only increased to 5.1% from 5.0%. We weren’t caught off-guard in a meaningful way. And maybe that’s why stocks are paring losses as the morning wears on. The Dow dipped 400 points at the open, but is now flat.

I’ve just spent a lot of text on a single market event, and am reminded that it never pays for investors to be too myopic. So let’s take a step back and look at the big picture. What we’re witnessing is a process of normalization. Capital markets, housing, employment, consumer spending and fiscal & monetary policy were broadly and profoundly distorted by the Covid Crisis. It will take time to bring all the trends and numbers back in line. We’re living through a period of slowing growth in order to get control of inflation. This means “re-rating” of investments to lower valuations. And at some point valuations become attractive enough to turn the tide of selling into buying. This is exactly why Warren Buffett consistently advises buying when fear is at its highest level.