Roadmap through year-end: Near-term volatility followed by potential recovery

DEWITT, Mich. - Sept. 6, 2022 - PRLog -- Last Friday, Jerome Powell told investors at Jackson Hole that the Fed is committed to raising rates and fighting inflation until it "gets the job done." This past week, financial markets took that message seriously. We saw equity markets fall and bond yields rise somewhat, even after a resilient jobs report on Friday. Nonetheless, markets are still forecasting a 75 basis-point (0.75%) rate hike at the September FOMC meeting and a terminal fed funds rate of close to 4.0%, with expectations of Fed rate cuts removed from mid-2023 forecasts. While the near-term may be volatile, we see a case for markets to stabilize heading into year-end, driven by two key factors: midterm elections and a potential Fed pause in 2023.

Financial markets prepare for more Fed rate hikes and no pivot in the months ahead

At last week's Jackson Hole economic symposium, Jerome Powell delivered a concise and pointed message for markets: The Fed is committed to raising rates, and keeping them elevated, until inflation comes down in a meaningful way. Chair Powell acknowledged that this process could bring some pain to the labor market and broader economy as well. Notably, the labor report for August still reflected a relatively resilient labor economy, with the unemployment rate ticking just modestly higher to 3.7% -- although this may continue to soften in the months ahead as Fed rate hikes continue. After last week's Jackson Hole economic symposium, market expectations seemed to reset. Not only did this accelerate the sell-off in equity markets and push bond yields higher, but there was also a notable shift in forecasts for the fed funds rate. Prior to Powell's speech, markets had been pricing-in Fed rate cuts starting in mid-2023; however, expectations now call for a Fed pause, but no pivot in 2023.

Markets are now entering the historically volatile months of September and October with a Fed and global central banks poised to move rates higher and implement quantitative tightening balance sheet reduction programs.

Inflation should continue to moderate

Investors will now be squarely focused on incoming inflation readings, which will determine the path of the Fed going forward. Perhaps the good news here is that several signs point to peak inflation still being behind us. We continue to see softness in oil and commodity markets (although these are volatile series), last week's ISM manufacturing prices paid index fell to the lowest levels of the year, wage gains are steady, and the housing market is starting to cool, as mortgage rates climb higher. Nonetheless, inflation may take months to move decisively lower, as several components may be sticky, including rent, shelter, and broader services inflation.