Over 150 years ago, during the Battle of Mobile Bay in the American civil war, one Admiral Farragut gave the order that created the birth of the oft quoted phrase – “damn the torpedoes”. The order was in fact made to the captain of his flagship to barge through the mines and ships that guarded the entrance of the bay. In similar fashion, Federal Reserve Chair J. Powell and the FOMC have been given the gargantuan task of wrestling the highest inflation rate in decades down to the ground, even in the face of an increasing number of dismal economic indicators.

 

Well, today, the order was given, and the Fed hiked its overnight interest rate target three-quarters of a percent to 1.75%.  In nominal terms, this isn’t a big deal. At this level we are still 0.75% below the peak in the previous cycle back in 2019. And both the bond market and stock market have already priced in this move.  It is the change that is going to grab headlines, since the last time we saw the Fed raise rates this much in one year was back in 1994. 

 

 

This is also the fastest pace of monetary tightening in a long while.  With today’s move, the Fed has increased its target by 1.5%, or 150 basis points, (from its first hike in March).  That represents an average daily increase of 1.1 basis points. In the last cycle, the average daily tightening over the period was 0.2 basis points and prior to the Financial Crisis, the pace was 0.6 basis points per day. You would have to go back to 1989 to get anything close to the current pace.

 

That assumes, of course, that the Fed continues at this pace and the prevailing argument is that the Fed preferred to get a massive rate hike out of the way to (A) assert that it is serious about getting inflation under control, and (B) to induce enough additional softening in demand to ensure inflation does fall. We have already seen signs of cooling off, from retail sales to manufacturing to housing. The core rate of inflation in the US has fallen in the past two months and, this morning, it was reported that import prices fell by 0.1% excluding petroleum.

Today also coincided with the beginning of the Fed’s quantitative tightening agenda, whereby it is no longer reinvesting the proceeds of maturing bonds that it has purchased during its quantitative easing programs. That has exacerbated the rise in bond yields, sending the 10yr US treasury to 3.5% and that has seen the 30yr bullet mortgage rate in the US break above 5.5%. 

 

The consequential weakening in economic demand and the rising probability of a recession has led the market to – wait for it – start pricing in actual rate cuts at some point in 2023 in order to restore economic order. Ally and I believe that inflation is going to moderate in the second half and this is going to take the heat off the Fed for additional massive tightening. In that environment, there is a window for risk assets to recover.

 

On behalf of the Pyle Group, have a wonderful day.

Andrew

 

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