by Alex Harding, CFA
Vice President, Equity Research
As expected, the Federal Reserve raised its target interest rate this week by 0.25% to 5.25 – 5.50%, marking the eleventh increase since March of 2022, bringing the interest rate to its highest level in 22 years. Notably, given the strong performance of the job market and positive changes in inflation data, the Fed staff revised their predictions and no longer anticipate a recession as the most likely scenario. However, they still expect a slowdown in economic growth.
Overall, the Fed’s messaging remained very similar to its statement in June. While the door was left open for additional hikes, the market believes we’ve seen the last increase of this cycle. We subscribe to the market’s thinking on this. The chart below shows that this has been the fastest Fed tightening cycle in 40 years. Knowing monetary policy takes time to impact the economy, and it’s only been 16 months since the first hike, the full effects have likely not been felt. As we look ahead, the Fed has two upcoming job and inflation reports that will play a crucial role in their decision-making process regarding interest rates at their September meeting.
Source: Federal Reserve
Bank Merger
In March, the failure of Silicon Valley Bank and Signature Bank indicated the first signs of cracks in our economy due to higher rates. The banking industry continues to encounter obstacles despite recent improvements in stability. As a result, many banks are implementing measures to pare down their balance sheets. For example, despite successfully selling off loans and assets to improve capital levels, PacWest Bank announced an all-stock merger with Banc of California on Tuesday to further strengthen its balance sheet. Fortunately, in stark contrast to the bank failures earlier this year, the government was not involved in brokering the transaction, and the merger was not done to address liquidity issues, as deposits only decreased by 1% since March 31. Both factors should reduce the perceived risk for the industry as banks continue to shore up their balance sheets. It wouldn't be surprising to witness more regional banks merging to compete more effectively with national banks and manage the growing complexity of regulatory requirements.
A Positive and a (Potential) Negative
Headlined by mega-cap tech stocks such as Alphabet, Meta and Microsoft, 167 companies within the S&P 500 index reported second-quarter earnings results this week – the busiest week of the earnings season. Although reported corporate profits have exceeded Wall Street’s expectations by 6%, the outlook for remaining earnings reports is not as optimistic. Earnings are expected to decrease by 8% compared to the previous year due to the significant decline in oil prices, negatively impacting the energy and material sectors. However, most industries remain resilient and exhibit growth. While the frequency of corporate management teams discussing topics such as recession, layoffs and supply chain issues appear to have peaked, forward guidance remains cautious given the uncertain operating environment from higher interest rates. As a result, we continue to take a more defensive approach to our sector positioning within stocks.
Takeaways for the Week
The Fed raised its benchmark rate by 0.25% to the highest level in 22 years
Economic activity continues to defy recession fears, with U.S. Gross Domestic Product (GDP) advancing +2.4%, led by consumer spending
Company earnings have beaten analysts’ expectations, but profits are expected to be lower than a year ago