Getting Comfortable with Fed Hawkishness

Stocks are swinging around between positive and negative this morning. Now that the market has given up about half of its mid-June to mid-August rally, we’re sort of range-bound. Crude oil continues to fall—now around $84/barrel—on global recession fears. Of course, the good news is that national average gasoline is down to $3.75/gal. Inflation is clearly moderating. Bonds are selling off again today, allowing yields to move higher along with interest rates throughout the economy. The Federal Reserve is driving a massive revaluation of fixed income securities, as evidenced by the iShares 20+ Year Treasury Bond Fund (TLT) down more than 26% this year.

Fed Chair Jerome Powell, speaking at a monetary policy conference, repeated his commitment to fight inflation. His view is that the Fed must “act now, forthrightly, strongly as we have been doing, and we need to keep at it until the job is done.” He acknowledged that the cost of that fight is “a period of growth below trend.” His goal is to slow consumer spending and hiring activity in order to bring the economy back into “balance.” Though his comments were nearly identical to a recent Jackson Hole speech, I get the sense that bond traders are only now getting comfortable with the probability of another .75% interest rate hike when the Fed’s policy committee meets later this month. The Fed-funds futures market currently expects another 1.3% of rate hikes before the end of the year. And we’re hearing that the Fed’s ultimate rate destination is about 4%.

Despite the pain already inflicted by the Fed on stock, bond & housing markets, the US economy has held up reasonably well. That is, economists generally predict slightly positive economic growth both this year and next. The Fed itself forecasts growth bottoming out at 1.0% in 2023. This would be consistent with a “soft landing” scenario, in which inflation is subdued without triggering a recession. But this outcome is by no means certain. Certainly, the Fed’s track record isn’t that encouraging. But this time may be different. The key to avoiding a recession may lie in the job market. Bloomberg opinion columnist Connor Sen says that a strong labor market “gives the Fed more of a cushion to slow things down without the economy falling apart.” He believes the Fed is trying to bring conditions back to pre-pandemic levels, and that means reducing monthly job growth from this year’s roughly 370k per month to about 200k. That’s a lot of cushion.

Bloomberg News reports a significant slowdown in San Francisco home prices. This is one of the most ridiculously expensive markets in the nation, but rising mortgage rates and an “exodus” of tech workers are taking a toll. According to Redfin, home prices in the city are 7% lower than year-ago levels. (Nationwide prices are up 7%.) The number of home sale transactions in San Francisco is down about 25%.