Interest Rates and Inflation
Key Points
The S&P 500 is up 16% Year-to-Date and is almost back to its pre-2021 levels.
Since the start of this market correction, we have consistently preached patience and discipline.
Issues in focus for the second half of the year include the future direction of the Federal Reserve, inflation dynamics, and consumer strength.
Let’s discuss each one of these topics.
Interest rates: The End of a Hiking Cycle?
For more than a year, the Federal Reserve has consistently increased interest rates by at least .25% at every meeting. After ten consecutive increases, the Federal funds rate now stands between 5 and 5.25%, its highest level since 2007.
Last week the Fed decided to hold rates steady. Observers and analysts were quick to claim that this marks the start of the Fed’s policy reversal, and that rates will begin to fall as early as September.
The enthusiasm was short lived. In his post-meeting speech, Fed chair Jerome Powell insisted that further rate hikes are necessary to tame inflation. In fact, he hinted that another two increases are likely in 2023. If this is not enough to make inflation fall to a level the Fed deems acceptable, more rate hikes could follow.
We all wish for a return to monetary normalcy, low inflation, and a strong stock market.
For now, we advise investors to expect an additional two rate hikes in the coming months.
Inflation: Cooling but Still Above Target
In parallel to the Fed’s announcement, the U.S. Consumer Bureau revealed that overall inflation reached 3.8% in the year through May 31st. That’s the first time YTD inflation dipped below 4% since late 2021.
Unfortunately, this figure does not account for fuel and housing. “Core inflation”, which includes the two categories, was 4.6% for the period. This is slightly inferior to the 4.7% economists expected, but still well above the Feds 2% target.
Is this slight disinflation reason enough to celebrate?
All in all, inflation is still running hot, but there are encouraging signs it may be coming under control. If we do see disinflation, the Fed may consider this a victory and start reversing course. At writing, we think that the worst of the inflation crisis is behind us and that the Fed is close to winning the battle.
But the battle is not yet won.
Consumer Strength: A Pillar of Stability
The easing inflation is reassuring American consumers.
For example, Deloitte’s Financial Wellbeing Index, which captures how American households feel about their present-day financial health and prospects, is on a noted uptrend since hitting a low in June 2022, when inflation peaked at 9.1% and seemed unstoppable.
Now, consumers are becoming optimistic about their savings, their overall financial situation and ability to finance large purchases. Does this mean they will start injecting capital back into equities?
Last year’s market crash encouraged a “flight to cash” that saw major inflows to money market funds. As is often the case, investors panic sell their positions when equities crash and seek safety.
If consumers regain confidence in the economy, they may shift their capital back into equities, which would drive a market rally. For this reason, it is important to remain invested and strengthen core positions to capitalize on the bounce back.
A Look Ahead: Preparedness and Optimism
Moving forward, we remain cautiously optimistic.
Despite the uncertainty, it is becoming increasingly obvious that the Fed’s policies are working, and that inflation is starting to cool.
As the saying goes: “time in the market beats timing the market”.
For this reason, we always remind our clients to always remain invested during troubled times, as this ensures that you don’t miss the rebound and ensuing gains.
We are convinced that we are well positioned to capitalize on the continuing market recovery: our investment team has been accumulating shares of exceptional companies with solid business models and exciting growth prospects.
If you have any concerns or would like to discuss your portfolio strategy, please contact us. We are happy to chat and explain our reasoning in further detail.
Anders Storvik
Client Advisor- Partner
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