The Federal Reserve intends to move more aggressively in fighting inflation. The Fed will likely do this via a series of 50 basis point rate hikes, beginning with the May Federal Open Market Committee meeting. This is going to be the first time in 22 years that the Fed has doubled the normal 25 basis point increase.
Chairman Powell remarked at a panel discussion at the IMF on April 21st that it is appropriate “to be moving a little more quickly” on rate hikes. He also communicated that, according to him, financial markets are “acting appropriately generally.” This means that markets are adjusting to the expectations of higher rates and the recent volatility is generally to be expected in light of the anticipated rate hikes.
Markets are forward-looking, so prices today reflect what markets think will happen in the future. Markets are having trouble interpreting this rate increase information because we have yet to see corresponding data showing whether or not rate hikes are working. Until we have more data to work with, we can expect continued volatility.
Has Inflation Peaked?
March inflation reached a 40-year high at 8.5% annualized. This inflation rate wasn’t a surprise, but it’s still a startling number for consumers. The remaining question is whether the Fed actions and a gradual resolution of supply issues will help inflation to resolve relatively quickly, or if inflation is here to stay longer term.
There is one positive note: Core inflation, which is defined as all prices except food and energy, fell in March. As we enter late spring, warmer weather will likely bring down energy costs. Additionally, consumer and government pressure may result in lower prices at the pump as oil companies bring more drilling online.
Bond yields have increased significantly, and the dollar remains relatively strong as US growth continues to outpace that of other countries.
Why does this matter? Historically, the dollar appreciates at the start of Fed hiking cycles. And a stronger dollar means imports are less expensive, which could help offset inflationary pressures.
Are Markets Concerned About Global Growth?
The war in Ukraine has had an immediate and drastic impact on global growth. The IMF recently released a report on the world economic outlook that found lower growth would be likely.
The IMF is projecting that global growth will slow from an estimated 6.1% in 2021 to 3.6% in 2022 and 2023. This is 0.8 and 0.2 percentage points lower for 2022 and 2023 than projected in January. Beyond 2023, global growth is forecast to decline to about 3.3% over the medium term.
What is Happening with Earnings?
What’s happening at the company level is also important. After four record quarters of earnings results in 2021, investors are looking to the second-quarter earnings season for insight into where the markets are headed.
Over one-third of the companies in the S&P 500 have reported earnings this quarter and, so far, nearly 80% of them have beat the Wall Street analysts’ expectations. We typically only see around 60-70% of companies beat earnings expectations.
While revenue growth is likely to be strong, earnings per share expectations are moderating. This means that margins may be getting stretched – and companies with pricing power will be in better shape to withstand ongoing inflationary pressures.
How Should Investors React to the Market Volatility?
Increased market volatility is normal given the number of economic variables that remain unclear currently. Markets really dislike uncertainty. However, the overall takeaway is that the fundamentals of the economy remain strong.
Demand for consumer goods is strong. Demand for better wages and more job opportunities are leading more people to return to the labor markets. Additionally, The Institute for Supply Management is reporting signs of resolving supply chain issues.
For investors with long-term investment horizons, it’s best to stay the course of your financial plan and your investment strategy. There’s no reason to try to predict what direction these economic variables will go in the short-term.
The Bottom Line
We’re definitely at an inflection point when it comes to inflation, interest rates, and global growth. Inflection points feel tense but remaining disciplined in the face of uncertainty is the best time-tested strategy.
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