When driving a car or riding a bike, you need to shift gears from time to time depending upon certain factors such as the speed you are traveling and the incline of the road. A gear change generally happens quickly and multiple times throughout a trip. If you are investing for the long-term, which you should be, there are going to be changes, not only in your individual situation as life happens but also in your portfolio as a result of changes in the markets. And when it comes to the markets, we are now seeing the beginning of a shift.
The Federal Reserve hiked interest rates by another 75 basis points, or three-quarters of one percent; the sixth rate hike of the year and fourth consecutive hike of that magnitude. After the Fed’s monetary policy statement, equity markets initially moved higher with the flick of a possibility the Fed might slow, or even pause, rate hikes. But it wasn’t the rate hike that was the real news. During the Fed’s press conference, Chairman Jerome Powell quashed any ideas of the central bank pausing rate hikes anytime soon. The message was that the Fed may slow the pace of the hikes but the forecast of the terminal rate, or peak in interest rates, is now higher than it was just two months ago, signaling a slight shift in expectations. The terminal fed funds rate is now expected to be reached in May, 2023 compared to the previous expectation of this occurring in March, 2023.
The shift in Fed expectations also contributed to the steep move higher in bond yields with the spread in yields between 2-year and 10-year U.S. Treasuries reaching the largest inversion since 1982. Interest rates on the short end of the yield curve rose to the highest levels since 2007. Moves higher in longer term rates have especially had an impact on the housing market, which has been hard hit by the shock of 7% mortgage rates and is seen weighing on economic growth.
The Long Road
Equities were lower last week after posting back-to-back weekly gains. After the Fed press conference on Wednesday stocks fell sharply as investors reversed previous bets on the possibility of a pivot or pause. It is still widely anticipated the Fed will pause at some point next year to assess the impact of rate hikes, but that does not necessarily mean they will pivot. 85% of S&P 500 companies have now reported earnings with a blended growth rate less than what was expected at the end of the quarter, according to FactSet. Despite growth rates coming in below expectations, the markets have reacted mostly favorably. This is likely because of a low bar being set, results being better than feared and the possibility of oversold conditions.
Labor market reports last week were mixed with the headline numbers being positive and ahead of consensus. However, underlying data shows a mixed bag. Average hourly earnings increased more than expected, leading to the narrative that wage pressures continue to contribute to inflation. The unemployment rate moved higher, but much of that was attributable to the number of people leaving the workforce. While some of the data may be troubling, this is only one month’s worth of data so should not yet change views on the long-term trends of the economy. But it could be warnings signs of what might be coming. And it is labor market resilience that is a key factor contributing to the “higher for longer” narrative. The hope is that the labor market will remain healthy while softening enough to allow inflationary pressures to abate.
week brings the mid-term elections where current projections are that there will be a shift in control of Congress. This remains to be seen and is contingent upon several key races, which at this point appear to be very tight. If such a shift were to occur, it would likely lead to gridlock since there would be different parties in control of the executive and legislative branches of government. Markets tend to prefer gridlock, which may especially be the case today since there has been a large amount of government spending, arguably contributing to ongoing inflationary pressures. There is likely to be a sharp reaction in the markets immediately following the election but it could be rather short-lived and we want to remind readers to remain focused on the long-term.
Also of great significance this week is the monthly release of the Consumer Price Index (CPI). While not necessarily the favored inflation measure of the Federal Reserve, this is the most widely accepted measure of inflation. What will be of most interest is the Core CPI, which excludes food and energy. Headline CPI, while remaining quite elevated, has slowly been trending downward over the past couple of months but Core CPI continues to move higher. Currently futures are pricing in a 50/50 split in expectations for rate hikes of 50 and 75 basis points (one-half and three-quarters of a percent, respectively) at the December Fed meeting. The CPI report is likely to push probabilities in one direction or the other.
As we mentioned at the onset, you will likely need to make modifications and adjustments in your retirement plan, especially as shifts occur in the markets. We are here to ensure that despite these changes your retirement plan stays on track. Contact us if you would like to discuss your individual plan to ensure you are making the changes necessary to arrive at your destination.
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
Please contact us if you would like to review your individual financial plan or learn how the TaxSmart™ Retirement Program can help you.
Office phone # 952-460-3260