By Andrey Dashkov, analyst, Casey Research
Instead of a sprint up a hill, it’s going to be a slow hike up a mountain.
The latest Fed meeting made it clear: the pace of interest rate increases is slowing. We won’t see a 75 basis points (or 0.75 percentage point) increase every time, as we did four times over the past several months.
On the other hand, the terminal rate (where the Fed thinks it will stop hiking) may have increased. It’s now around 5%.
In other words, it will be a slower path toward a higher peak.
So, what does this mean for investors?
First, There’s No Pivot Yet
After the Bank of England suddenly reversed course last month and started buying government bonds in response to a shocking policy announcement from the British government, people thought the Fed would do the same.
So far, though, it hasn’t.
On the contrary, the Fed continues to tighten its monetary policy, which includes raising rates.
This means it’s less concerned about the markets than it is about driving inflation down.
Of course, the markets weren’t pleased. On the day of the announcement, November 2, they had the worst “Fed Day” since January 2021, according to Bloomberg.
The S&P 500 declined by 2.5%.
What’s more, analysts agree that there is going to be no “Santa Pause,” meaning a possible end-of-year break, in the Fed’s hiking cycle. That’s bad news for investors, as we won’t be seeing any relief soon.
Second, the Pain Will Last Longer
Slower hikes mean that it’ll take more time to reach the terminal rate.
This gives the Fed more time to observe what the rate hikes so far are doing to the economy.
It makes sense from the Fed’s perspective, but the markets should brace for more volatility ahead. The Fed is consistent: It doesn’t care about the stock market.
So investors should brace for a longer period of pain. 2023 isn’t looking pretty for tech stocks, highly leveraged companies, or bonds in general.
What Should You Expect?
Right now, it’s likely the Fed will hike by 50 basis points during its next meeting and probably by 25 basis points afterwards.
Futures markets point at a 5% terminal interest rate sometime mid-2023.
What should you do?
Expect a recession, as we have predicted for a while.
High inflation and high interest rates make it almost impossible to engineer a “soft landing.” When both readings are at decades-high levels, anything could happen. It’s uncharted territory, and so far, the Fed has proven that it can make colossal mistakes.
(Investors won’t forget how the Fed expected the post-COVID inflation to be “transitory.”)
The extreme conditions of end-2022 and the first half of 2023 will prove the Fed both too slow to react (it should have started hiking earlier) and too aggressive.
But it’s not all doom and gloom. The Fed’s latest moves have two implications that you can use to your advantage.
First, the U.S. dollar is rising against other currencies. Its relative value is based on interest rates, and the Fed is currently one of the most powerful central banks.
To profit from a more expensive U.S. dollar, consider the Invesco DB US Dollar Index Bullish Fund (UUP). The value of this ETF’s share price rises as the U.S. dollar grows more costly relative to other countries’ currencies.
Second, protect your portfolio from rising interest rates. The most straightforward way to do that is by buying an ETF whose value is directly linked to rising rates.
Simplify Interest Rate Hedge ETF (PFIX) does just that. This ETF hedges against future interest rate hikes, which will be helpful in the face of a possible recession.
Analyst, Casey Research