After a strong rally since the beginning of summer, stocks began to retreat after the S&P 500 rejected its 200-day moving average last week. The focus has returned to the macro backdrop, with a series of weak activity readings across the global economy. US housing data remains extremely weak with mortgage rates moving up again, mortgage applications falling, and other metrics continuing to miss. To add to that, July inflation came in lower than expected and decelerated.
All of this data suggests the Federal Reserve might begin to pivot from their current path of aggressive monetary tightening. We believe this is primarily the reason markets rallied close to 20% off the June lows. But Jay Powell confirmed at the Jackson Hole symposium that US monetary policy is wholly focused on bringing inflation and inflation expectations back down to the Fed’s 2% target. After Powell declared “our responsibility to deliver price stability is unconditional,” risk assets sold off as investors concluded any hopes of a near-term Fed pivot to an easier stance were misplaced. The Fed did not blink. Higher stock prices, tighter credit spreads, and lower bond yields undercut the Fed’s fight against inflation. Ultimately, rallies are still self-defeating and give the Fed more room to hike. (Chart 1)
Therefore, we believe that Fed tightening will remain in force. This not only means more interest rate hikes, but also an acceleration in the Fed’s program of quantitative tightening (QT), this month. Basically, one month does not yet make a trend and inflation expectations are still too high to warrant a proper pivot from the Fed. Therefore, while relief might be in sight, peak relief is still pending.
Currently, global monetary tightening remains extreme. Global policy rates are the highest since 2008. The level of rates is not at an extreme yet, but the rate of change is. Over the past year, policy rates have risen at the fastest pace since 1989. (Chart 2) Policy rates are high and rising, with a high likelihood of further acceleration in both the pace and level of rates to come. Eventually, this sort of policy action will have unintended consequences. That’s especially true in a world with high debt loads.
For markets then, accelerated QT coming on top of further interest rate increases will amplify the liquidity squeeze already under way. Ultimately, markets are still at an inflection point. Despite all the negative, we still do not believe we will experience a deep recession in the next 12 months. That means, largely all of the economic damage that we’ve highlighted has been priced into markets. However, there will continue to be volatility while the Fed and the market play chicken. We expect both equities and bond yields to remain range bound until there is more progress made on inflation. Risks remain elevated and we are aggressively monitoring the chances of a deeper economic turmoil.
Recent Portfolio Changes
There have been no changes to the portfolio positioning since July 19, 2022.
Changes to Holdings
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John A. Forlines III
Chief Investment Officer
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