Weekly Investment Update (06/17/2022)

Fed Hikes 75bps After Hot Inflation Report and Increase in Inflation Expectations

The Fed delivered a 75bps increase in interest rates on Wednesday, the central bank’s largest rate hike since 1994. The FOMC has now increased its target range by 150bps over the course of three meetings. The Fed indicated that another 50bp or 75bp increase would be appropriate in July. FOMC rate projections have now moved up to 3.4% by the end of the year, an increase from 1.9% in the March summary of economic projections (SEP).  

During the press conference, Chair Powell emphasized the Fed’s commitment to price stability, stressing the urgent need to bring inflation down and keep longer-term inflation expectations anchored. Powell explained that the hotter-than-expected CPI report as well as the increase in inflation expectations in the University of Michigan survey prompted the Fed to alter its prior plan for a 50bp rate hike at the June meeting and to front load hikes. 

Powell openly discussed taking rates into restrictive territory with the aim of cooling inflation, acknowledging the likelihood of unemployment increasing as a result. Furthermore, Powell admitted the path to bringing inflation down while engineering a soft landing was becoming more challenging amid a backdrop of exogenous and uncontrollable supply shocks. Citing the war in Ukraine, higher oil prices, and the impact of China’s COVID lockdowns on supply chains, Powell underscored the many factors out of the Fed’s hands that are impacting inflation dynamics. 

Another key focus of the press conference was the future path of rate hikes. Powell noted that forward guidance was highly uncertain and would be incredibly data dependent on the month-by-month path of inflation. Thus, each inflation report is likely to be influential over monetary policy in the months ahead. The Fed stressed that moving forward they were very closely watching both inflation data as well as inflation expectations.

Central Banks Remain Flexible and Data-Dependent, a Stance that Intensifies Market Volatility Given the Lack of Explicit Clarity on Policy 

It is clear the FOMC is serious about tightening monetary policy to bring inflation down. Ongoing upside inflationary surprises are pressuring central banks to act, and we are factoring the Fed’s evolving plans into our rate and growth forecasts. Based on Powell’s comments at the press conference, we believe the Fed is likely to deliver another 75bps hike in July before slowing down the pace of tightening thereafter. According to the FOMC’s projections, the Fed is expecting an additional 175bps in rate hikes by year-end; meanwhile, the market is pricing in 200bps of hikes; 75bps in July, 50bps in September and November, and 25bps in December.  

The Fed has very clearly highlighted its flexible and data-dependent approach to future hikes, which leaves the path of monetary policy highly uncertain and partly dependent upon external factors. Inflationary data is being driven, in part, by energy dynamics, notably the war in Ukraine. We are closely watching oil and gas prices for any indication of easing of commodity-related inflation, which in turn could ease the pressure on central banks to tighten as aggressively. Two potential key catalysts that could have a meaningful impact on energy prices would be a settlement of the war in Ukraine or improvements in U.S.-Saudi relations. 

Without improvements to the supply backdrop, the Fed’s main option to tame inflation is by slowing aggregate demand. Indeed, the Fed’s hawkish shift is already evident in notably tighter financial conditions, including a stronger dollar and a weaker housing market given rapidly increasing mortgage rates. Additionally, retail sales fell in May as higher interest rates and inflation likely prompted consumers to pull back on spending. 

Most Central Banks Continue Hiking While Japan Remains the Outlier 

Aside from the Fed raising rates this week, global central banks are generally shifting more hawkish amid the increasingly uneasy view on inflation. Central banks in Switzerland and Hungary hiked rates by more than anticipated, while Brazil hiked inline and Taiwan raised a bit less, but all continued the trend of policy tightening globally. Notably, Thursday’s 50bp hike from the Swiss National Bank (SNB) from -75bp to -25bp was its first hike in 15 years as they embrace currency appreciation as a means of dampening imported inflation pressures. 

The pivot from the SNB amplified already intense focus on the Bank of Japan (BoJ). With the SNB turning more hawkish, the BoJ is the last big central bank sticking to accommodative policy. However, on Friday, the BoJ reiterated that it is still too early to cut back monetary easing and raise rates in Japan, despite recent market pressure on the currency and government bonds, as inflation remains relatively muted.

The combination of central bank tightening and upward pressures on energy costs is pushing yields higher around the world, dampening equity sentiment. In response to the higher yields and pressures on energy costs, Bessemer’s All Equity Model Portfolio has increased exposure to more defensive areas by adding exposure to healthcare and consumer staples, as well as to energy and broader commodities, which historically outperform in higher inflationary environments.