On June 15, 2022, the Federal Reserve increased the Federal Funds rate by 75 basis points. Since then, you’ve probably heard a lot of chatter from economists and pundits about the implications. You might be wondering: where do we go from here? Stagflation? Inflation? Short-term deflation? Slow growth? No growth? There’s a lot to unpack, so let’ s dive in!
It’s important to first understand the reasoning behind the increase. Rampant inflation is evident everywhere we look in our daily lives, from the grocery store to the gas station to raw building materials. After a long stretch of lenient monetary policies, the Fed had a tough decision to make with no easy answer. They could let inflation continue unchecked, or try to temper it with an aggressive rate hike in a bid to regain the credibility of the institution.
They clearly chose the latter, but it will not be without consequences and may well send the US into a recession. On a positive note, they have an opportunity to ease the policy again should the need arise. However, zombie companies will struggle to borrow enough or meet debt obligations, sending them over the financial cliff. The rate hike will also force consumers to spend less, cooling down an economy that has been firing on all cylinders.
Historically speaking, tampering with inflation with a short-term focus in this way can indeed lead to a recession. Getting inflation under control requires a significant drop in demand and spending. It’s a complex puzzle to solve and there are many other factors that weigh in or signal what we can expect going forward.
For starters, corporations are projecting higher-than-expected forecasted earnings and EPS growth rates, an excellent sign that the economy will eventually prevail. Even if, as expected, we fall into a mild recession, it will be short-lived. The economic fundamentals are sound. Though many of the major players are reporting hiring freezes, mass layoffs have not yet been announced – another good sign. Weaker companies may ultimately fold, but those that are strong and agile will weather this storm and perform even better once the dark clouds blow over.
There are some other notable indicators that a short-term recession may be imminent. The US GDP growth projections are being revised downward by most economists. The yield curve is starting to show signs of inverting, which happens when short-term Treasury yields begin to exceed long-term yields.
Of course, the US is not the only nation facing inflation and a potential recession. It appears to be a global economic condition. In fact, the Swiss National Bank just recently increased interest rates by 50 basis points to protect its currency and avoid imported inflation. This could be the start of a coordinated global increase as other nations scramble to protect their own currencies. This footrace could stir up additional harm to an already fragile economy in the near future.
Meanwhile, the dollar reserve status is under threat due to geopolitical tensions, making an uncertain financial future harder than usual to predict. There is no historic model to which we can look for insights, learnings, and expectation-setting. On one hand, a resilient economy humming along, with robust employment rates amidst increasing inflation. On the other hand, the repercussions of Russia’s war on Ukraine and another round of COVID lockdowns in China are exacerbating supply chain shortages and crippling almost every industry.
With so many unknowns, the future in incredibly difficult to predict and could prove challenging for most portfolios. However, we still see opportunities in this deleveraging and amidst the movement out of risky assets. Holding cash is still not a recommended option, especially when there are value plays to be made in precious metals, shipping, and commodities (oil, gas, base metals, Uranium, and food).
In short, our models are forecasting *probably* a recession, but not a terribly long one, and we’ll recover swiftly.
