The Federal Reserve (Fed), on top of a third straight 0.75% rate hike at the September FOMC meeting, has made it clear that their commitment to price stability won’t be deterred by the threat of economic pain. Financial conditions will tighten, and an economic slowdown (and likely recession) implies that an earnings downturn is also on its way. All of which spell trouble for risk assets.

FOMC dot projections
September 2022

Line graph showing individual FOMC member projections and median FOMC projections by percentage from 2022 to beyond 2025.

Federal Reserve, Clearnomics, Principal Global Investors. Data as of September 2022.

For over a decade, risk assets benefited from significant monetary tailwinds. Policy rates were kept low, and even when the Fed did raise rates, it did so in a slow and steady fashion. That era is firmly in the past. At the September FOMC meeting, alongside a third consecutive 0.75% hike, Chair Powell gave notice that rates are moving considerably higher and will stay higher.

The Fed dot plot sees policy rates rising 125 basis points in the last two meetings of the year, taking rates to 4.4% by year-end and then further to 4.6% by end-2023. No cuts and no pivot until 2024. Policy rates at end-2024 are also expected to be higher than they are today. The “lower for longer” narrative has now shifted to “higher for longer.”

While this aggressive pace of hiking should bring inflation closer to the 2% target, it will also likely bring economic hardship. The unemployment rate, for example, is expected to rise from 3.7% currently to 4.4% by end-2023. While 4.4% is low by historical standards, it’s the 0.7% increase that matters: the unemployment rate has never risen 0.5% without the economy entering recession.

The Fed’s tolerance for economic pain doesn’t bode well for risk assets. Financial conditions will tighten further, and recession implies an earnings downturn is approaching. Get defensive, times are getting tougher.


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