How big will the hike be in March? … the key variable that will determine what the Fed actually does in 2022 … what to watch instead of the Fed
The single largest influence on your portfolio in 2022 will be the Fed.
As we’ve been covering here in the Digest, we’re standing at the cusp of a rate-hiking cycle intended to tamp down the worst inflation in 40 years.
By the admission of some of the Fed’s own members, they’re already behind the curve. This leaves them with a challenging tightrope to walk…
Tighten monetary policy too much and they could kneecap economic growth.
But tighten monetary policy too little and inflation could continue burning through consumer pocketbooks.
Wall Street has been highly volatile in 2022 as it tries to get a bead on what the Fed will do. Today, one of the immediate uncertainties is how much the Fed will raise rates in its March meeting.
Earlier this week, James Bullard, president of the St. Louis Fed, said he’s in favor of a 50-basis point hike and wants to see a full 100-basis point increase by July 1st.
Here’s The Wall Street Journal with the market response and the resulting policy tightrope:
(Bullard’s) remarks accelerated the largest one-day jump in two-year Treasury bond yields since 2009 and led futures markets to bet on a half-point increase next month.
If Mr. Powell and his colleagues deliver such a move, they could be criticized for panicking. If he opts for the smaller increase, he could be criticized for not taking inflation seriously enough.
I reached out to our InvestorPlace analysts for their thoughts on what will happen at the Fed’s March meeting, as well as where rates will end the year. Most importantly, I asked what it will mean for the stock market.
Let’s see what our experts are expecting.
***Is a 50-basis point hike coming in March?
A quick disclaimer.
Our InvestorPlace analysts approach the markets from varied perspectives and come to their own, unique conclusions. There is no pressure to toe a party line or arrive at a similar narrative. Given this, you’ll read different opinions below.
Here’s a suggestion…
You probably have your own general idea of what the Fed will do. Challenge it by evaluating the opposite outlook below, whatever that is.
You might find the exercise strengthens your current opinion. Or you might find yourself reconsidering your stance. Either way, there’s value in trying on the opposite perspective.
Returning to the possibility of a 50-basis point hike in March, let’s begin with our technical expert, John Jagerson of Strategic Trader:
Yes, a 50-basis point hike looks pretty likely.
Bond traders see a nearly 70% chance for a hike as of (Monday), but that estimate can change quickly if we get unexpected news (e.g., a Russian invasion of Ukraine.)
The market has been pricing in a higher and higher probability of a 50-basis point hike over the last month. Last week, bond traders were only expecting a 20% probability for a hike of that size.
Since the “expectation” numbers we can see come from bond prices, it is safe to say that a 50-basis point hike is priced into the markets. However, as I mentioned before, if we experience a global risk event (Ukraine invasion), the probability will likely fall a lot.
For a different perspective, let’s turn to our hypergrowth expert, Luke Lango:
The Fed won’t hike 50 basis points in March. Zero chance.
Powell has a history of being the most dovish Fed chair in history, and immediately after Bullard went to market with his 50-basis-point talk in the Bloomberg interview last week, multiple Fed members spoke out in opposition to the idea, instead preaching a gradual hiking process.
They’re going to hike 25 basis points in March. After that, they’ll sit back and see how the market takes that rate hike. They’ll watch the CPI and PPI prints. They’ll watch the stock market. They’ll watch the yield curve.
You have to remember: This is a very data-driven Fed that always errs on the side of being dovish, and while rhetoric doesn’t scare them into enacting loose monetary policy, poor economic data and stock market crashes do.
To Luke’s point, it was Powell who began to hike rates back in 2018, only to run into a 20% market pullback when Wall Street said “no more” after the Fed took rates up to 2.5%.
This led the Fed to give up its rate hiking program. And, in fact, they were cutting rates not long thereafter.
Luke believes we’ll see the same thing this time around.
***Why the narrowing yield curve could limit how hawkish the Fed gets
As we look to where rates might end 2022, legendary investor, Louis Navellier believes we’ll see three, maybe four hikes, not the higher predictions some analysts are throwing out.
Here’s Louis with more:
The bank strategists that are calling for five to seven rate hikes are clueless and bomb throwers for cheap press.
The yield curve has narrowed, which is bad for financial stocks.
Luke also points to this narrowing yield curve as a reason why the Fed won’t move too fast.
The yield curve has flattened tremendously to an ultra-narrow spread of just 40 bps between 10s and 2s.
Never before — in the history of the central bank — has the Fed hiked aggressively into a flattening curve to ultra-narrow levels. In fact, every time we’ve seen yield curve action like that before, it has preceded rate cuts!
If you believe the Fed is going to hike 8 times in 2022, I have beachfront property in Oklahoma I want to sell you.
***The stock market outcome that the Fed wants to avoid
The Fed’s stated dual mandate boils down to promoting maximum employment and maintaining stable prices.
But there’s a third, unspoken mandate – avoid market meltdowns.
Though this isn’t publicly stated, all you have to do is look at the Fed’s actions over past decades to see that this is a massive goal.
Yes, the Fed wants to tamp down inflation. But it also doesn’t want to destroy the stock market. With this in mind, let’s return to John’s thoughts on rate increases in 2022.
Pay special attention to the added variable he throws into the mix:
If everything remains constant between now and the end of the year, a hike to 1.75 -2.00% would be catastrophic for stocks.
However, if growth rates pick up again, it wouldn’t be a big deal.
My point is that rates are only one part of the question. We have to ask what if rates rise and growth doesn’t? (Really bad for stocks). Or what if rates rise, but growth rises proportionally? (Neutral for stocks.)
In our view, growth will remain positive but is unlikely to accelerate, so if the Fed were determined to raise the overnight rate to 2% by December, it would be bad.
However, the Fed’s plans (like all investors’ plans should be) are conditional and tentative. So, we don’t think they will persist in hiking rates if growth doesn’t justify it.
Luke sees growth as a key variable as well. Here’s his take on what will happen with growth, as well as the Fed’s response:
Stocks will remain choppy against the backdrop of Fed risks, inflation risks, and now geopolitical risks.
The yield curve will continue to flatten as investors worry about the Fed hiking into a slowing economy. And inflation data will meaningfully decelerate in March, April, and May, and consumer spending and manufacturing activity will fall flat in those months, too.
As all that happens, this Fed will change its tune, dramatically and rapidly.
After a few rate hikes, this Fed will — by the end of summer — turn completely dovish and pull back on monetary tightening in the face of a slowing economy with rapidly falling inflation.
***Are we missing the point by focusing so much on the Fed?
Our macro specialist, Eric Fry, provided a thoughtful take on the issue that refocused the discussion on what’s likely to have a bigger impact on your portfolio.
The Fed’s actions are more pomp than circumstance, especially because the Fed’s current actions are following the market, rather than leading it.
Long-term interest rates, which the Fed does not control, have been rising since last summer. The yield on the 10-year Treasury has nearly doubled since then – jumping from 1.13% to 2.06%.
But the Fed has not yet budged from its zero-interest rate policy. Obviously, multiple rate hikes are on the way, beginning with the first one next month.
The Fed says it will begin nudging interest rates higher to head off the inflationary threat. But you can’t “head off” something that you are chasing from behind. And that is exactly what the Fed is attempting.
It is “behind the curve” in the battle against inflation, to use the phrase professional investors toss around. And because it is behind the curve, its rate-hike campaign is mostly ceremonial…and irrelevant.
So, what is not ceremonial, according to Eric?
The direction of interest rates in the fixed income markets.
Eric writes that this is where millions of transactions happen every day, establishing the free-market level of interest rates. And in this world, rates are already exploding.
Back to Eric:
In just the last three months, for example, the average nationwide 30-year mortgage rate has skyrocketed from 3.05% to 4.2%. That’s the sort of “rate hike” that could hobble both the housing market and consumer spending.
Presumably, long-term rates like these would not be screaming higher if bond investors genuinely believed the Fed was waging an effective battle against inflation.
These long-term rates are not yet flashing red, but they are flashing amber.
So as a stock market investor, I’m keeping a much closer eye on 10-year Treasury yield and the 30-year mortgage rate than I am on the “sound and fury” issuing from the Federal Reserve.
***Boiling everything down
So, how do we cleanly sum-up all of these perspectives?
In one sense, we can’t. Nor is that important. As mentioned at the top of this Digest, our analysts have differing views, which we encourage.
That said, here’s a general sum-up:
- The size of the rate-hike in March is a toss-up, with our analysts mixed on whether or not we’ll see a 50-basis point hike. But even if it is 50-basis points, it’s not likely to result in fireworks because such a hike is becoming increasingly expected
- Looking over the entire year, growth will have a huge impact on what the Fed actually does. All the tough talk about multiple hikes will fade if growth isn’t there
- The Fed is behind the curve, and it’s reacting to the market. Therefore, keep your eye on Treasury yields and mortgage rates for an idea of what’s actually going to happen
We’ll keep you updated here in the Digest.
Have a good evening,