So far, U.S. securities markets have stumbled into 2022. Despite healthy underlying economic growth, the markets have fallen significantly from 2021’s recent highs. They’re struggling to find a bottom amid uncertainty regarding inflation and how the Federal Open Market Committee (the Fed) will mitigate it.
Inflation Is Still Here
Originally thought to be a short-lived inconvenience of waking up the global supply chain一and a consequence of excess stimulus dollars一inflation has proved to be unexpectedly tenacious. It’s now entrenched within wages, housing, energy, and other everyday expenses. Consider the data:
- The Consumer Price Index for All Urban Consumers (CPI-U), a measure of the average price change of a basket of consumer goods over time, rose a staggering 7.0% for the 12 months ending in December 2021—the largest 12-month increase since June 1982.
- The Personal Consumption Expenditures Price Index (PCE), which excludes the more volatile food and energy sectors, also came in at a record-breaking 5.5% for the same period, the greatest 12-month increase since February 1991.
The Coronavirus Pandemic Continues to Impact the U.S. Recovery
To complicate matters, the U.S. economy continues to feel the perpetual whiplash of the novel coronavirus pandemic一with the highly contagious omicron variant providing the most recent head smack. Intermittent changes in guidance, testing protocols, and policies have delayed a comprehensive national reopening and have further spooked millions of workers from returning to work.
What Will the Fed Do & When?
The Fed must act to bring inflation under control sooner than initially scheduled. It’s already accelerated tapering (or decreasing) purchases of government bonds (which adds cash to the economy) from a $15 billion reduction in December to a $30 billion decrease in January. At this rate, tapering would be complete by March 2022一a few months earlier than originally planned. The first rate hike is expected to be in March 2022 and quantitative tightening (selling of the balance sheet) to possibly start by the middle of 2022.
Some would argue that having to scramble at all一regardless of the schedule一is a stumble in itself. “Clearly, inflation has been more persistent than the Fed initially thought and many anticipated. And in hindsight, they should’ve acted sooner,” says our Co-Chief Investment Officer Alex Oxenham. He adds, “Instead, they’re forced to act just as inflation is peaking and growth is beginning to roll over.”
The question for the Fed, then, is a tricky one of timing and degree. It will be difficult to get inflation under control without stifling future growth. In Oxenham’s words, “It’s going to be very challenging for the Fed not to make a policy mistake, especially if inflation pressures persist.”
Our Current Thinking
While we feel the Fed is behind the curve on inflation, we also think it’s too early to determine the magnitude or exact pace of intervention that’s needed. We believe inflation is in the process of peaking, with disinflation (declining inflation and growth) on the way. However, more economic data and Fed guidance is required to determine long- and short-term economic impacts.
For now, we’ll continue to position our portfolios carefully, anticipating that the Fed will likely raise rates sooner than projected. To that end, we’ve focused on maintaining balanced portfolios across sector, factor, and style allocations. The coronavirus pandemic has also wreaked havoc with traditional economic cycles. Pivots within the portfolios are happening more quickly and decisively than ever. As always, we’ll continue to rely on our disciplined investment approach that’s served our clients well across past market cycles.
Once the Fed’s plans for tapering and quantitative tightening become more apparent, a reevaluation of portfolio strategies and necessary accommodations will follow. Stay tuned.
To find out more, contact Hilton today.
