Nowhere to hide (continued)

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George Kessarios
Chief Economist & Fund Manager

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As expected, and as economists expected, the Fed raised rates by 50 basis points and announced policy pertaining to QT (quantitative tightening). The wording from Chairman Powell suggests that there are at least 1-2 more 50 basis point hikes ahead, and then a slowing down of tightening policy. The Fed has no easy choices because as rates increase, the risk to growth also increases. However, Powell made it clear again and again that his No1 priority is inflation and will use all means to combat it no matter what the cost.

Chairman Powell made the point that the labor market was very tight, with job openings outstripping the available supply of labor. In fact, he even said that unemployment needed to go up a bit for labor supply imbalances to even-out.

But as depicted in the above chart, employment levels in the US have not returned to pre-pandemic levels. There is plenty available labor out there, it just does not want to return to work.

The Fed wants to reduce the “surplus demand” in the US economy, and it admitted that there is no easy way to do that. As such, the Fed has decided to increase the cost of capital as a way of achieving this goal. The latest data from FreddieMac shows that 30-year fixed mortgages in the US are 5.27%, up from about 2.5% of a year ago.

And as the chart above from the US Mortgage Bankers Association shows, the average monthly mortgage payment went from about $1300 between 2019 and 2021, to a little over $1700 today. So yes, eventually consumers and business will reduce their “surplus demand” and the Fed will get its wish. The question is will this combat inflation?

The US had negative GDP in the first quarter. Generally speaking, as long as the US consumer is doing well, the US economy is generally ok.

However, as the chart above shows, consumer confidence in the US is falling off a cliff and is rivaling the recessions of 2008 and 1980s.

Over the past several years US consumers for a whole host of reason had accumulated lot of savings on the side. Today those savings are gone.

As the chart above shows consumer savings are at the lows of 2013. What this basically means is that it will be very difficult for the consumer to keep the US economy growing over the next several quarters. In other words, it is very likely that the US will see negative GDP growth, perhaps for the next several quarters ahead.

At the same time the Fed admitted (finally) that most of the inflationary pressures have to do with supply shocks, that are outside of tis control. As a reminder, these supply shocks are the on-going Covid pandemic, high energy prices, and the recent war in Ukraine. And since the Fed can’t do anything about energy prices -- which is he biggest component of recent inflationary pressures – it has decided to lower demand by making everyone in the US poorer.

Please note this is the opposite of what the ECB has done, saying that monetary policy should still stay as is, because the reason for inflationary pressures are outside of its control.

Adding everything up, in my opinion the Fed is making a policy mistake. In fact, this will prove to be the second policy mistake chairman Powell will make, the first being his insistence on raising rates and trying to shrink the balance sheet in 2018-2019.

Insofar as the markets, after the Fed announcement on Wednesday US market rallied hard, only to give everything back and then some on Thursday.

As I said in our 2022 outlook, there is nowhere to hide with Fed policy being so hawkish. Mind you that the carnage is not limited to equities but has also spread to bonds. On a positive note, a lot of hot air is coming out of the market, especially in Cathie Wood type companies, and overall equity prices here and there are once again becoming compelling investments. But finding companies that can go against this tide requires hard work, and in many cases nerves of steel.

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