Financial markets have had a brutal week, with declines that accelerated after Fed Chair Jerome Powell made it clear that they intend to aggressively hike interest rates into 2023. For the here and now Powell increased the Fed Funds rate by .75% to a range of 3%-3.25%. This move was widely expected. But what wasn't widely expected was the change in the forecast of a Fed Funds rate of 4.4% by this December, up from their previous projection of 3.4%.

An example of the impact higher rates are having on the economy is the cooling of the housing market. The rate on a 30-year mortgage has gone from 3% in January to 6.70% now. This has put a chill into housing activity with mortgage applications at 20-year lows and a significant decline in new-home sales. The Fed made it clear they wanted housing to cool off. That is exactly what has happened and yet Powell did not acknowledge this.

In June when the Fed increased rates by .75% for the first time Powell cited soaring gas prices and an increase in consumer expectations of inflation as items of concern. Since then gasoline costs have declined from $5.10/gallon to $3.66/g. Also, today oil prices have fallen to below $79/barrel, down from $125/b earlier this summer. Again, this is particularly good news in the Fed’s fight against inflation.

We have seen a similar dynamic play out with inflation expectations. In their latest report, the NY Fed showed that consumers expect forward inflation of 2.76%, down from 3.90% in June and 4.21% in late 2021. So all of this begs the question, why was Chair Powell so darn hawkish? Last year we were very vocal that the Fed was making a major mistake by not taking inflation seriously and continuing to believe inflation was “transitory”. We believe now that they risk compounding that mistake by raising rates too far, too fast if they continue a path to 5% by March 2023.

A silver lining of the sell-off in the bond market is that we have begun buying individual bonds and bond ETFs for clients that are yielding greater than 4%. We are also starting to see investment-grade corporate bonds yielding over 5%. These are the highest yields that have been available in over 15 years.

There is one more silver lining we want to point out. AAII’s Investor Sentiment report was released yesterday and it showed that investors are the most bearish they have been since March 5th, 2009. That was less than one week before the stock market bottomed following the Great Financial Crisis. The S&P 500 was up 67% over the following year from that bearish reading on March 5th. Now we are not saying that we will see a similar rally over the next year, but when investor sentiment gets this bearish, stocks tend to perform very well over the following year. On a shorter-term basis one can see a similar phenomenon if you look at a near 60% bearish reading in mid-June that corresponded with the stock market hitting its low close of the year and it proceeded to rally for two months.

So while the last few weeks have been no picnic for financial assets, opportunities have been created with the best opportunities in the bond market in 15 years. Next week we will be putting out a video where we dive deeper into the Fed’s latest projections and why we believe the Fed will be making a mistake if the projections become reality. We will also highlight some positive developments from the latest jobs report and recent consumer data. We hope you have a good weekend.

Hawkish Powell Rattles Markets