The eye of a hurricane is a deceptively dangerous place. Those lucky enough to enter it unscathed may enjoy a well-deserved rest, however the blue skies and calm winds also give a false sense of security and encourage complacency. Some people may even be convinced that the storm is over. However, the reality is that the attention only offers a temporary respite and the worst is yet to come back.
On July 27, 2022, the US Federal Reserve increased the important thing rate of interest by 75 basis points. Many investors had feared a more aggressive 100 basis point hike, so the relief was noticeable. The very next day, the Bureau of Economic Analysis (BEA) released its expanded estimate of second-quarter GDP growth. The negative Q2 value of 0.9% was followed by a Q1 decline of 1.6% and sparked an unnecessary debate about whether the U.S. economy was in recession.
The combination of a smaller-than-feared rate of interest hike and two consecutive quarters of negative economic growth sparked a robust rally in U.S. stocks and other risk assets. This rally was accompanied by hope that the Fed could soon ease its monetary tightening and that the dreaded recession was already within the rearview mirror.
Twelve-Month Trailing US Inflation and Cumulative Federal Rate Hikes: Post-World War I/Great Flu and Post-COVID-19
As July become August, a surprisingly good jobs report and lower-than-expected CPI numbers made investors much more optimistic. It’s hard in charge them for basking within the sunny skies and losing sight of the second wall of hurricanes which may be looming on the horizon. While such optimism could also be tempting, it contradicts the teachings of monetary history – particularly the US experience within the years after World War I and the years before the Great Inflation.
The Fed is now fighting inflation, not recession, and it is just too early to declare victory. The biggest mistake within the Fed’s history was allowing inflation to fester for too long within the late Sixties. The Fed’s mistakes caused inflation expectations to firm up, and the U.S. economy paid a heavy price in the shape of greater than a decade of stagflation. The Fed under Jerome Powell is unlikely to repeat this error, and decisively containing inflation will likely require much more effort.
Beware of October’s ideas
So when will the second wall of the monetary hurricane strike? It’s inconceivable to say. The Fed could even defy the percentages and engineer a soft landing. But when the storm comes, beware the Ides of October 2022. Not only will the Fed’s tightening cycle be in its late stages, but October can also be a notorious month for financial panics. The nineteenth Century Agricultural Finance Cycle First, there have been periodic panic attacks in October, but even after the United States transitioned to an industrial and consumer economy, the instinctive fear of October occasionally triggered self-fulfilling prophecies.
Financial history suggests that more market volatility and economic problems lie ahead before the Fed wins its battle against inflation. However, this doesn’t mean that investors should aim for tactical asset allocation – that may be speculation relatively than investment. Rather, they simply need to take care of situational awareness, stay true to their long-term asset allocation goals, rebalance toward those goals if needed, and proceed to steel their nerve for further volatility and price declines.
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