During our collective years in investment management, we’ve come to use several phrases over and over. Our long-time clients may begin to roll their eyes as we repeat an oft-used phrase, “The Fed is raising rates for the right reason.” Investors worry so much about the Fed overreacting or underreacting and derailing the economy, they forget that it is healthy for the Fed to raise interest rates. What is unhealthy is to sit at 0% on short-term rates when inflation and the economy are both running hot.
Today’s monthly employment report was nothing short of fantastic. Employment increased by over 450,000 people, when expectations were running at about 125,000. Wages continue to be strong, and so strong in fact, that over 1 million people have reentered the work force. With Omicron, retirements and childcare keeping people out of the work force, it was feared that we were already at full employment. That is not the case, and we expect additional people will come back to the work force in the coming months. This employment recovery will not be a straight line, and there will be disappointing numbers from month-to-month, but the trend for improvement is in place. This should provide cover for the Federal Reserve to raise interest rates in a reasonable manner.
The market over the past several years has tended to overestimate the amount of Fed rate hikes each year, see below:
Sources: Northern Trust Asset Management, Bloomberg, Federal Reserve
What most people miss is that the Federal Reserve is never on “auto pilot.” They weigh what is going on in the economy month to month, and then decide the appropriate course of action. Historically, economists have been overly aggressive in assuming Fed rate tightening cycles, and then something happens in the economy that causes the Fed to pause. That may or may not be the case this year,. As always, it depends.
What we have said is that the equity ride in 2022 will be bumpy. Fears of inflation, and an overreaction from the Fed will cause upheaval as we move throughout the year. This is understandable, as the Fed has been ultra-loose with their policy and will be less accommodative in the future. Our belief is that the economy is on sound footing, and in that environment the Fed should be raising interest rates.
Our Takeaways for the Week
“The Fed is raising interest rates for the right reason”
2022 will be a more volatile year for the stock market as we simultaneously judge the strength of the economy and inflation, and the possible Fed response