by Alex Harding, CFA
Vice President, Equity Research
Although investors hoped the change of seasons would bring a change to the news headlines, in recent days global central banks managed to stay front and center as the Bank of England and Bank of Japan took swift action to provide stability within their respective currency and bond markets. Domestically, Federal Reserve officials were busy defending their “unconditional” stance on tackling inflation. Not surprisingly, capital markets remained under pressure as the prospects of higher-for-longer interest rates and slower economic growth were being digested.
As the chart depicts below, the pace at which the Fed’s target interest rate has increased this year is the fastest we’ve seen over the past seven tightening cycles. The Fed has made it clear their policy rate must move to a level restrictive enough that demand softens while moving inflation closer to their 2% goal. Despite tight labor markets giving the Fed cushion to aggressively pursue price stability, there is a growing worry from market participants the Fed may overshoot, driving the economy into recession. Recently, we’ve seen signs the economy is softening as evidenced by the decline in commodity prices, rents, freight costs, home prices and money growth. In addition, we’ve seen stocks revisit their June lows, the U.S. dollar spike, and daily interest rate moves of a magnitude not seen since March of 2020. It begs the question – would a near-term pause by the Fed be appropriate?
Source: Bloomberg
Time to Travel
For those travelling abroad this holiday season, round trip tickets may not be cheap, but U.S. residents will be pleasantly surprised when they exchange U.S. dollars for the country’s local currency. The combination of strong economic growth and the Fed’s interest rate hikes has strengthened the U.S. dollar considerably against every major currency, making travelling abroad much cheaper. While beneficial for travelers, one consequence of a strong dollar is its negative impact on international stock returns as foreign prices must be converted back into U.S. dollar terms. As of this writing, international equities are down -16% in their local currency, but when converted to dollars for a U.S. investor, the return falls to -27%.
Source: Refinitiv
After rallying in August, both stocks and bonds took a round trip back to their lows to close out the third quarter. There is no way around it – 2022 has been a challenging year for investors with very few places to hide. Capital markets respond instantaneously to new changes in interest rates whereas it takes many months for the impact to be transmitted throughout the underlying economy. Although we are not yet in recession, currently down over 20%, the equity market has already discounted two-thirds of a typical recessionary drawdown. While painful in the moment, we do not think that now is the time to blink and sell stocks.
“Far more money has been lost by investors trying to anticipate corrections, than lost in the corrections themselves” – Peter Lynch
Takeaways for the Week
August Personal Consumption Expenditures price index, the Fed’s preferred measure of inflation, was released on Friday with the Core reading (excl. food & energy) coming in 0.2% higher than expected at 4.9% year-over-year driven by price increases from the services sector
The U.S. dollar has been on a tear this year – benefitting travel abroad but hurting investor returns