The financial markets have not stabilized since last quarter. Upside surprise for inflation, continuation of Russia invasion of Ukraine, slow recovery of the supply chain, and global central bank raising rates all contributed to dampening economic growth and elevating uncertainty. Although we believe inflation in the U.S. may have peaked and is beginning to come down, the process of returning to a 2% inflation environment will likely be painful and dragged out.
The Fed is committed to fighting inflation after waiting until this year to begin its interest rate hiking cycle. Most observers believe that the Fed is behind in containing inflation and is now looking to frontload its rate hikes in a still relatively decent economic environment. The factors contributing to the current bout of inflation are partially demand (consumer) driven, but much is attributable to supply (commodities, production and supply chain disruptions). The direct impact from hiking rates or tightening financial conditions is on the demand side as consumers tend to spend less and borrow less in a restrictive environment. But rising rates do not often impact supply side. It would take much more financial pain to bring consumption down so much that it affects the cost of supply.
Chair Powell and many of the FOMC members maintain that they see a path to an economic “soft landing”, meaning bring inflation back down to 2% without triggering a recession. In our opinion, a recession is no longer a possibility but an increasing probability. There are signs of this economy slowing and future corporate profits being adjusted downwards. During this period of uncertainty, stocks will continue to underperform and lose value. As such, cash and certain bonds would be favored.
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