Fed Rate Hikes Are Finally Starting to Threaten Stocks. Be Warned.


rate hike - Fed Rate Hikes Are Finally Starting to Threaten Stocks. Be Warned.

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Economic momentum is slowing, and it’s slowing fast. What’s less obvious is the link between this slowdown and the cycle of rate hikes that began over two years ago.

Last week, the second estimate of Q1 GDP was revised down from 1.6% to 1.3%, and a sharp decline in pending home sales furthers the argument that things could soon turn ugly. This cooling in the real estate market is possibly due to higher mortgage rates putting a strain on affordability, and it seems lumber sensed this all along. Despite ongoing narratives around the resilience of the housing market and demand staying strong, lumber, which is critical to home construction, never really reflected that optimism.

We are very likely looking at lagging indicators, those impacts that emerge after – sometimes long after – significant shifts in correlating variables such as world events or changes in economic policy. The fastest cycle of rate hikes in history can indeed still create a big disruption.

Delayed Impacts of Historical Rate Hikes

Monetary lags resulting from policy actions such as changing interest rates can become apparent throughout the economy at any point in time. No one knows when. Not me, not you, and certainly not Federal Reserve Chair Jerome Powell. Ongoing increases in the federal funds rate can take quarters or years to fully work their way through the economy, affecting GDP growth, employment and inflation.

Read that again – it can take YEARS for the effects to be felt. They might show up as ordinary lags such as shifts in consumer behavior or changes in firms’ willingness to invest in new plants and equipment. Sometimes, though, the world can appear to defy the conventional playbook, with lags taking unprecedented forms we cannot predict. And nothing about the last few years has been conventional.

There is always a lag between higher interest rates and slower economic activity. Late last year, everyone began celebrating how Powell pulled off a “soft landing,” but we might only now be witnessing the effects of his monetary tightening. The dramatic drop in pending home sales and weak GDP revision could be among the first indications of this.

We remain in a precarious position from an asset allocation and investment perspective, which is why I lean more toward dividend stocks and high-quality bonds right now. If the lags are indeed starting to hit, volatility on average will be up, and the economy may bring more negative surprises.  

On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

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