With just under two weeks left in 2022, investors are evaluating where they stand and making decisions for how to approach the new year. 2022 marked the beginning of tightening monetary policy by the Federal Reserve to tame elevated inflation. After maintaining near zero interest rates to boost the economy during the Covid pandemic, the Fed came to realize the elevated inflation figures were not transitory and strong action was needed.
Despite lower inflation figures in November that came in at 7.1% YOY from 7.7% in October, the Fed still sees a strong labor market and, therefore from their perspective, further interest rate hikes are required. Powell announced a 0.5% rate increase in December, slowing down from previous rate hikes of 0.75%. Nevertheless, his hawkish speech on maintaining elevated rates throughout 2023 was not received positively by investors. Investor sentiment is more aligned with the reality that even though CPI numbers are moving in the right direction, they are still elevated. The S&P 500 Index has resumed the downtrend that began earlier in the year and is down over 18% YTD.
S&P 500 Index (SPX) YTD Daily Chart 2022
The bottom line from the FOMC’s December meeting is that the Fed is committed to slowing down the economy and increasing unemployment to reign in still raging inflation. Furthermore, the Fed is not considering cutting rates anytime soon. The Central Bank will only start cutting rates when they see inflation declining in a consistent and sustainable manner.
The Fed says a soft landing is still possible, yet how probable is it? This week demonstrates that recession fears are looming greater in the minds of consumers, and the Fed’s track record does not inspire confidence. In the last nine out of the 12 times the Fed has tightened monetary policy, the U.S. economy has fallen into a recession. Therefore, we are not in a favorable position to start the new year. Market veterans like Felix Zulauf, recently interviewed in Barron’s, see inflation coming back strongly by the end of 2023 and even higher than the current cycle in 2024 and 2025. In addition, Zulauf sees oil prices rising sharply in 2024-2025. He compared the current cycle to the 1970s, where the second wave of inflation really hurt the bond market and anticipates an even worse bear market in bonds in 2024-2025. Furthermore, Zulauf sees a less globalized world where companies prioritize secure supply chains over cheap ones which will further stoke global inflation. Will commodities be the answer in this decade? Only time will tell, however, what is clear is that the next decade will be very different than the previous one.