Market & Economic Outlook
Market Commentary - Q3 2022
Equity and bond markets were hammered in the second quarter as inflation soared and the Federal Reserve began a cycle of significant rate hikes. This put a couple of worrisome questions into the spotlight: Is the risk of a recession growing? How can investors prepare for upcoming volatility?
Paying the Piper
The government’s massive fiscal stimulus response to the COVID pandemic, some $5 trillion over the 12-month period ending March 2021, along with the Fed’s aggressive series of rate cuts in the first quarter of 2020, unleashed a stampede into risk assets, ranging from stocks to high yield bonds.
Now, the economic pendulum is swinging back. Near-zero rates distorted the cost of capital and fiscal interventions prompted excess consumer demand. This combination of events has sparked today’s soaring inflation – creating a monetary “beast” that the Fed’s recent and abrupt about-face hopes to tame.
During Fed Chairman Powell’s June meeting with the Senate Banking Committee, he reconfirmed the Fed’s “strong commitment” to bring inflation down from 40-year highs.
But the prospects for a soft landing—taming inflation without dragging the economy into recession—are becoming increasingly unlikely. According to Powell, such an economic outcome would be “very challenging” and a recession, he stated, is “a possibility”.
We believe a mild, “garden variety” recession is rapidly becoming a base case scenario for the U.S. economy with the most significant impact focused on consumer credit’s support of the auto and home sectors.
One encouraging difference between today and the recession of 2008/2009 is that the U.S. banking system is less vulnerable to some of the forces, including bond derivatives and subprime loans, that led to banking stresses in the “Great Recession”. Also, this time around, contagion from risk asset class bubbles is less likely: bitcoin and NFT troubles are unlikely to materially impact traditional equities and bonds.
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