The Federal Open Market Committee (FOMC) hiked the federal funds rate by 25 basis points (bps; 100 bps equal 1.00%). There weren’t any major changes to the policy statement. One thing that looks increasingly likely, though, is that this last rate hike is the last rate hike. Yes, Federal Reserve (Fed) officials will be “data dependent” and they likely want to keep their options open when it comes to hiking more. But if the data roll in as I expect, we’ll see inflation continue to fall and the labor market show signs of weakness. Those two forces—lower inflation and weakening labor market conditions—could push the Fed to hit the pause button on further rate hikes.
For investors, it’s good to not be surprised when others are. Portfolio managers don’t diverge from the consensus view without purpose and without conviction in their views. Here are a few things we’ve been talking about around Allspring where our expectations may diverge from the consensus viewpoint and what we’re doing about it.
- There’s already been a profits recession even if there hasn’t been an economic recession. So, why not take volatility as an opportunity to position for a recovery? Overweighting areas like mid-cap value, large-cap growth, and emerging markets can potentially help position for an eventual profits recovery.
- We’re closer to cruising altitude with central bank policy rates than many people fear. The sooner the Fed stops hiking and starts holding, the longer it can hold before needing to cut. When the last hike is indeed the last hike, that tends be bullish for equities, but especially for bonds. Historically, being early with a call that the end is here for rate hikes hasn’t been too costly with bonds. That’s why we don’t mind “hiding out” in fixed income.
- The labor market is only superficially strong. Aggregate hours worked has actually declined two months in a row, which is not what we’d expect with such strong payroll numbers. One of the data series is wrong. Maybe the economy is not as strong as the Fed thinks. While it would create some angst for the equity markets if we do see some big revisions to the data that reveal we weren’t as strong as we thought, a countervailing force is that the Fed “hawks” could change their feathers to be “doves.” The risks suggest to us that keeping things balanced between stocks and bonds can help navigate the uncertainty of 2023.
- Inflation will likely fall fast, but not far enough. We think inflation can fall fast, but probably not as far as the market is pricing in based on indicators from the inflation swaps market. (In an inflation swap, an investor pays a fixed rate and receives whatever inflation actually ends up being.) The market seems to think 2% inflation is only a year away. That may be overly optimistic, as the price deflation of goods can shift back toward modest inflation and services inflation can cool—but not enough to get us below 3% inflation within the next year. The last 1% point of deflation may be the hardest to achieve. That does create some upside risks for interest rates, which is why we like to keep our fixed income exposures more conservatively positioned.
Every year comes with its share of surprises. Some years have more than their fair share. We’re in the middle of earnings seasons, and with the Fed hike and then employment and inflation numbers coming up, the early part of February could have a year’s worth of surprises crammed into it. We think a good way to not have a portfolio shocked by the potential surprises may be to use any volatility as an opportunity to get back into balance and position for an eventual recovery.
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