When it comes to markets, always ask yourself what has the market discounted (and conversely, what it has not). As far as we know, another 75 basis points of tightening later in the day the by Fed is a given. For some reason, if the tightening is only 50 basis points that will be a big shot in the arm for the equity markets. It is very unlikely the Fed will go for a full 1 pct point hike.
On Thursday we should get the Q2 GDP report that should confirm the technical recession that we have been talking about.
The Fed had to do all this to put a brake on inflation but inflation is still out of control. The signal from the Fed to raise rates really killed the animal spirits in the economy. In April, that led to the inversion of the yield curve which normally acts as a precursor for a recession. That also led to the discounting of the recession in the stock market.
The net impact has been that we had the longest and worst stock market in 50 years in the first half of this year. So what does the second half of the year look like?
Firstly, we need to look at everything in context. With today’s possible hike of 75 bps the Fed funds rate will be in the window of 2.25% to 2.5%. In July 2019, this is exactly where the Fed stopped raising rates and reversed rates in July 2019. The Fed is not going to do anything like that now but the Fed could be pausing on hikes with today’s hike.
We have talked about this in length before. Why do we think the Fed will not go aggressive with the hikes considering inflation is still marching higher? Firstly it complicates the existing debt burden. Secondly, the dollar has been so strong and further hikes will invite a flood of capital into the US from all parts of the world.
With the debt burden more than 25% more higher than in 2019 and the dollar almost 10% stronger than in 2019 the Fed is forced to play a different role.
The lawmakers are still open to more fiscal spending on top of the six trillion that has been floating in the economy for the last two years. They have already done that with $280 bln spending with the “Chips Act”. Any sign of inflation topping out will encourage the Fed to put brakes on monetary policy.
All this gives us enough confidence to think that the second half of the year will be good for higher asset prices.
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Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and multi-billion dollar portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund.