The Fed Holds Course

By Deron T. McCoy, CFA®, CFP®, CAIA®
Chief Investment Officer

As many of us may have recently attended our first Back-to-School night in a few years, perhaps it might help to frame the Fed’s current situation in student terms. If a student misses a day of classes, the next day their workload is doubled – as they not only have that day’s homework to do, but also the previous day’s work to catch up on. If they’re out for a week, the task becomes that much harder. And if a student is out for an entire year, both the time and workload required to catch up can feel like an eternity.

That’s precisely where the Fed now finds itself. By missing class (or in the Fed’s case, not paying attention and subsequently failing to tighten monetary policy in the second half of 2021 and the first quarter of 2022), they’ve fallen far behind – making the path and journey back to normalization a long one. Whether the latest rate hike is 50, 75, or 100 bps is really immaterial. The question investors should be asking is not how high today’s hike was, but rather how long this will last. Looking purely at the data, a strong case can be made that this may be the investment landscape for a while. Consider what the Fed is watching:

• First and foremost is inflation. Has inflation cooled since their meetings earlier this summer? In short, no. Even with lower gas prices, higher inflation elsewhere in the economy has kept the monthly data point hot (with this week being just the latest example). = Nothing here would argue in favor of a policy change.
• Second, what about capital markets? Many have suggested that weakness in stocks or bonds might act as an unofficial nudge to the Fed Chair to change policy. Unfortunately for the doves, stocks are still actually higher than their mid -June lows and on par with late-July (the dates of the last two Fed meetings on interest rate policy). = Again, nothing here would suggest a change in policy.
• Third, what about debt markets? Have High Yield spreads moved higher; suggesting real stress in the credit markets? Again no. Credit spreads have actually moved lower from those summer meetings, suggesting stress has eased. = Strike three when it comes to a policy change justification. 

While anecdotal evidence suggest that the economy is cooling and inflation is rolling over, it’s simply not showing up in the hard data yet. And for the Fed to pivot amid 40-plus year highs in inflation, the institution would need to point to hard data for cover in their quest to restore some semblance of credibility. Thus, the 2022 outlook for the Fed (in fact their mandate) is still very much intact, which should continue to slow the economy over the coming months.

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